What is a sinking fund?

A sinking fund is indeed a reserve that is specifically set aside for the purpose of paying off debts or replacing assets. This financial tool allows an organization to gradually accumulate funds over time to meet future obligations or capital expenditures. By contributing to the sinking fund regularly, a company can ensure that it has the necessary funds available when debt payments or significant expenditures are due. This helps in managing cash flow efficiently and reduces the risk of financial strain when large payments need to be made.

In contrast, choosing an investment for high-return assets, such as in the first option, does not align with the primary purpose of a sinking fund. While sinking funds may achieve some investment returns, the emphasis is not on generating high returns, but rather ensuring sufficient funds for specific future liabilities. The third option relating to employee bonuses is unrelated to the nature or purpose of a sinking fund, as it deals with compensation rather than debt management. Lastly, an account for daily operational expenses would be categorized as working capital or operating funds, which do not have the specific long-term goal characteristic of a sinking fund.