Financial Management and Business Data Analytics · Introduction to Working Capital Management

Sources of Working Capital Finance for CMA Inter Students

Updated 10 October 2026 · Fact-checked

Working capital finance comes from short-term sources such as trade credit, bank cash credit, commercial paper and factoring, and from long-term sources such as equity, debentures and retained profits. Tandon and Chore committee norms decide how much a bank lends. To solve questions, identify the source, then compute cost or permissible bank finance.

Understand Sources of Working Capital Finance

Working capital is the money a firm needs to run day-to-day operations: buying raw material, paying wages and carrying stock and debtors. Every rupee tied up in current assets has to be financed from somewhere. That 'somewhere' is the source of working capital finance.

Sources fall into two groups. Short-term sources are repaid within a year. They include trade credit (suppliers let you pay later), bank finance (cash credit, overdraft, loans, bill discounting), commercial paper (an unsecured short-term promissory note issued by strong companies), factoring (selling receivables to a factor for immediate cash) and accruals such as outstanding wages and expenses. Long-term sources are equity, preference shares, debentures, term loans and retained earnings. They are used to fund the permanent part of working capital.

Trade credit is the cheapest and most automatic source. It costs nothing if you pay within the credit period, but it becomes expensive if you forgo a cash discount. Bank credit is the main formal source for most Indian firms. In cash credit, the bank sanctions a limit, and you draw and repay within it. Interest is charged only on the amount actually used, so it suits fluctuating needs.

Banks do not lend whatever a firm asks for. The Tandon Committee (1975) laid down norms so that credit follows need. It wanted banks to finance only a part of current assets, with the borrower bringing in a minimum share from long-term funds. This margin is called Net Working Capital (NWC). The Tandon Committee suggested three methods of lending. Method 2 and Method 3 each leave a larger share of current assets with the borrower than Method 1.

The Chore Committee (1979) reviewed the working of these norms. It recommended the second method of lending as the minimum norm, and asked banks to look at the borrower's total operations, not just one unit. It also suggested that the borrower should not hold excess current assets beyond the norm, and that banks should check use of funds through quarterly information. Remember: Tandon sets the methods, and Chore tightens how they apply.

Key rules to remember

Tandon Method 1: maximum permissible bank finance (MPBF): MPBF = 0.75 × (CA − CL), where CL excludes bank borrowings; The borrower finances 25% of the working capital gap from long-term funds. Here CA − CL is the working capital gap.
Working capital gap: Working capital gap = Total current assets − Current liabilities (excluding bank borrowings); Used as the base for Methods 1 and 2.
Tandon Method 2: MPBF: MPBF = 0.75 × Total current assets − Current liabilities (excluding bank borrowings); Borrower keeps 25% of total current assets as NWC. This leaves a larger margin with the borrower than Method 1.
Tandon Method 3: MPBF: MPBF = 0.75 × (Current assets − Core current assets) − Current liabilities (excluding bank borrowings); Core current assets are the permanent minimum level of current assets. They are funded entirely from long-term sources.
Current ratio under each method: Method 1: minimum current ratio of about 1.17:1; Method 2: 1.33:1; Method 3: a still higher ratio; These are the norms associated with each method, not figures you compute from a question's data.
Effective cost of factoring or discounting (annualised): Cost % = (Charges ÷ Net amount advanced) × (365 ÷ Days); Use the amount actually received, not the invoice value, as the base.

How to solve Sources of Working Capital Finance questions

Questions on this topic are either descriptive (explain sources, compare options) or numerical (MPBF, cost of a source). Use the same approach each time.

1Read what is asked: list of sources, a comparison, a cost, or permissible bank finance.
2For descriptive questions, group sources into short-term and long-term, then give a feature, advantage and limitation for each.
3For MPBF, list total current assets and current liabilities other than bank borrowings.
4Compute the working capital gap (CA − CL excluding bank borrowings).
5Apply the method asked: 75% of the gap for Method 1; 75% of current assets less current liabilities for Method 2; adjust for core current assets in Method 3.
6Check the current ratio after bank finance if the question asks for it.
7For cost of factoring or discounting, take charges as a percentage of the amount actually received and annualise.
8State a short conclusion, such as which source is cheaper or what the bank will lend.

Quickest way: Two-line MPBF check

When to use it: When a question gives balance sheet items and asks for permissible bank finance under Tandon methods.

Write current assets (CA) and non-bank current liabilities (CL) side by side.
Method 1: 0.75 × (CA − CL). Method 2: 0.75 × CA − CL.
The difference between the two methods is 0.25 × CL, so Method 2 always gives less bank finance when CL is positive. Use this to check your answers.
If core current assets are given, subtract them from CA before taking 75% for Method 3.

Common mistakes in Sources of Working Capital Finance

Including bank borrowings in current liabilities when finding the working capital gap.
Students copy every current liability from the balance sheet.
Fix: Remove bank cash credit and other bank borrowings. Only trade creditors, provisions and other non-bank current liabilities count.
Applying 75% to the wrong figure in Method 2.
Methods 1 and 2 look alike and formulas get mixed up.
Fix: Method 1 takes 75% of the gap. Method 2 takes 75% of current assets, then subtracts current liabilities.
Treating trade credit as free in all cases.
Students forget the cash discount offered.
Fix: Trade credit is free only if you pay within the discount period. If you forgo the discount, work out the cost of that decision.
Confusing the Tandon and Chore committee roles.
Both deal with bank lending norms and the names blur.
Fix: Tandon proposed the three methods of lending and the NWC concept. Chore reviewed them and recommended the second method as the minimum norm.
Using invoice value as the base when computing factoring cost.
Students assume the factor pays the full invoice.
Fix: Deduct the reserve, commission and discount charges. Use the advance actually received as the base.

Worked examples

Example 1

Bharat Textiles Ltd has current assets of ₹80,00,000 and current liabilities other than bank borrowings of ₹20,00,000. Compute the maximum permissible bank finance under Tandon Method 1 and Method 2.

Show the solution

Working capital gap = 80,00,000 − 20,00,000 = ₹60,00,000.
Method 1: MPBF = 75% × 60,00,000 = ₹45,00,000.
Method 2: MPBF = 75% × 80,00,000 − 20,00,000 = 60,00,000 − 20,00,000 = ₹40,00,000.
Check: difference = 0.25 × 20,00,000 = ₹5,00,000, which equals 45,00,000 − 40,00,000.

Answer: MPBF is ₹45,00,000 under Method 1 and ₹40,00,000 under Method 2.

Example 2

Sundaram Traders factors invoices worth ₹10,00,000 due in 60 days. The factor advances 80% of the invoice value and charges a 2% commission on invoice value plus 12% per annum interest on the advance, deducted upfront. Find the effective annual cost of the advance (use 365 days, round to one decimal).

Show the solution

Advance = 80% × 10,00,000 = ₹8,00,000.
Commission = 2% × 10,00,000 = ₹20,000.
Interest = 8,00,000 × 12% × 60 ÷ 365 = ₹15,780 (approx.).
Total charges = 20,000 + 15,780 = ₹35,780.
Net amount received = 8,00,000 − 35,780 = ₹7,64,220.
The cost is computed on the advance only. The remaining 20% reserve is repaid to Sundaram Traders when the invoices are collected, so it is excluded from the base.
Cost for 60 days = 35,780 ÷ 7,64,220 = 4.68%.
Annualised = 4.68% × 365 ÷ 60 = 28.5% (approx.).

Answer: The effective cost of the advance is about 28.5% per annum, computed on the amount actually received; the 20% reserve is repaid on collection and is not part of the base.

Exam tips

Write the formula for the method first. Examiners give step marks for the correct method even if arithmetic slips.
For comparison questions, use a two-column layout: trade credit versus bank credit on cost, security, flexibility and limits.
In MCQs, check whether current liabilities include bank borrowings before computing MPBF.
Learn one-line summaries: Tandon gave the three methods, Chore recommended the second method as the minimum norm and tightened monitoring.
End numerical answers with a one-line interpretation, such as how much the borrower must fund from long-term sources.

Practice questions from Introduction to Working Capital Management

Sources of Working Capital Finance in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Sources of Working Capital Finance: frequently asked questions

What are the main sources of working capital finance?

Short-term sources include trade credit, bank cash credit, overdraft, commercial paper, factoring and accruals. Long-term sources include equity, debentures, term loans and retained earnings. Firms usually fund the permanent part of working capital from long-term sources.

What is the difference between trade credit and bank credit?

Trade credit comes from suppliers and is spontaneous. It carries no interest if paid on time but may cost you a cash discount. Bank credit is a formal facility with interest, security and sanctioned limits, and is subject to lending norms.

What did the Tandon Committee recommend?

It recommended that bank credit should be based on need and that the borrower must bring in a minimum margin from long-term funds. It proposed three methods of lending. Method 2 and Method 3 leave a larger share of current assets financed by the borrower than Method 1.

What is the role of the Chore Committee?

The Chore Committee reviewed the Tandon norms in 1979. It recommended the second method as the minimum norm and suggested closer monitoring of how borrowers use credit.