A sinking fund is money set aside on a schedule for a cost that is known to be coming.
The difference from a strategic reserve
A strategic reserve is for the unexpected. A sinking fund is for the expected: replacing a van in three years, a certification renewal, an annual insurance premium.
One buys resilience, the other buys predictability.
Why it matters more than it sounds
Large occasional costs arrive whether or not the business has planned for them. Unplanned, each becomes a bad month or a borrowing decision taken under pressure, which is when borrowing is dearest.
Funded monthly, the same cost is simply a line in the budget.
What it connects to in the accounts
Depreciation already recognises that an asset is being consumed. A sinking fund is the cash equivalent of that recognition — putting aside what depreciation says is being used up.
Businesses that read profit without funding replacement find the two diverge at exactly the point the asset fails — see useful life and salvage value and fleet management.
Where to hold it
Separate from the operating balance, for the same reason as any reserve: money visible in the working account is spent — see real cash balance.
Escrow
Money held by a third party until a condition is met, common in property transactions and some construction contracts. It is somebody else's condition rather than the business's own discipline, and it is not available in the meantime — worth knowing when reading a cash position.
What is not a reserve
Tax money and collected sales tax. Those are owed to someone else and were never the business's to allocate.