A sinking fund is a fund that companies can contribute to to help pay short- or long-term debt obligations.
What is a sinking fund?
Companies that want to borrow money to finance operations may issue bonds on the open market. The terms of those bonds may vary, especially their duration and principal amount. For example, a company may issue 10 bonds worth $1,000 apiece, which expire in five years. This means the company would owe $10,000 at the end of the five years, plus interest.
Rather than paying one lump sum of $10,000, the company can contribute to a sinking fund to lower the payment due at expiry. If it contributed $1,000 to the sinking fund each of the five years (for a total of $5,000), the company would only owe $5,000 at the end of the five years. Sinking funds can improve a company’s credit rating and lower its interest rates for future debt obligations.