Whether you’re saving for a big purchase or making sure you’ve got the money to pay for unexpected costs, sinking funds are a useful tool to reduce financial anxiety and stress.
Read on to find out how sinking funds work, with some top tips from financial education expert Charlotte Jessop (@Lookingafteryourpennies).
What is a sinking fund?
A sinking fund is a pot of money that you top up regularly to cover big business costs such as tax bills or new software.
By saving a small amount of money each month, you can build up a large pot over time and pay off larger bills with less stress.
According to Charlotte Jessop, sinking funds provide built-in buffers for small business owners.
Speaking at the Simply Business How to manage your money in 2023 webinar, she said: “The point of this is that you’re ready for things you have coming up, but you can also have pots for things that are completely unexpected that you couldn’t possibly prepare for.”
She said this reduces the worry of where money is going to come from and stops business owners from thinking they’ll have to do extra work to cover a specific bill because the money is already there.
Sinking funds don’t need to be exclusive to business finances, they can also be used to save money for big annual personal expenses too, such as Christmas or car insurance.
How to use sinking funds for your business
Charlotte Jessop explained that sinking funds for small businesses can be used for three main purposes:
- Saving for big purchases
- Saving for unexpected expenses
- Saving to manage cash flow
Using sinking funds to manage larger annual payments
Small business owners can benefit from using a business bank account that allows them to open multiple mini savings accounts that can be used as sinking funds.
For example, you could have separate pots for annual costs such as:
Charlotte Jessop explained that you can use accounting software to tell you how much money you need for each bill and then move it into the relevant sinking fund when you get paid.
For annual costs such as website hosting, business owners can start a savings pot at the beginning of each year. If they take the full amount and divide it by 12, they can split the total bill into manageable monthly payments.
If your annual bill for website hosting is £360 and it’s due each May, you can start saving £30 a month from June. When it’s time to pay the next bill the following May, you’ll have the full amount in your sinking fund.
Even for businesses that get paid more sporadically (for example if you have a handful of big contracts each year), you can put a percentage of everything you get paid into sinking funds for your various costs.
Five money management tips for small businesses
Our research shows that money is the biggest concern for one in three small business owners in 2023, while 80 per cent said they’re worried about the cost of living crisis and the impact it could have on their finances.
Alongside tips on using sinking funds, Charlotte Jessop gave small businesses owners who attended our webinar some key messages to remember when managing their money:
- ‘Don’t cash out to splash out’ – it’s important to take a consistent wage so that your finances remain stable during lean and more fruitful periods
- Keep business and personal finances separate – making sure your finances don’t overlap can reduce stress and make it easier to manage business bills
- Don’t neglect your pension – small business owners should do their research and consider taking out a self-invested personal pension (SIPP)
- Manage prices with confidence – warn customers before you increase prices but don’t apologise for charging a fair amount of money for your services
- Keep good records – even if it’s just a basic spreadsheet, keeping track of incomings and outgoings makes it easier to analyse your financial position and prepare for things like tax
About Charlotte Jessop
Charlotte Jessop is the financial educator, coach, writer, vlogger, and podcaster behind the ‘Looking After Your Pennies‘ platform.
Her expert tips have been featured across the national media, including the BBC, Sky News, ITV, the Telegraph, and the Financial Times.
Charlotte’s advice ranges from free budgeting spreadsheets to five-day financial health checks.
Useful guides for small business owners
- What is Making Tax Digital – is your business ready?
- What are business rates?
- Self employed vs sole trader – what’s the difference?
- What does public liability insurance cover?
Do you have any unanswered questions about setting up a sinking fund? Let us know in the comments below.
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