Strategic Management and Corporate Finance · Sources of Corporate Funding

Short-Term and Working Capital Finance: Sources and Features

Updated 11 October 2026 · Fact-checked

Short-term finance funds a company's day-to-day needs and is repaid within about a year. Main sources are trade credit, bank overdraft, cash credit, commercial paper, factoring and bill discounting. To answer a question, match the source to the need, state its features, cost and risks, then conclude.

Understand Short-Term and Working Capital Finance

Working capital is the money a business needs to run daily operations: buying raw material, paying wages and waiting for customers to pay. Working capital = current assets − current liabilities (this is net working capital). Gross working capital is total current assets.

Short-term finance covers this need. It is raised for a period of up to about one year and repaid from the cash cycle of the business. Using long-term funds for permanent working capital is common. Using short-term funds for fixed assets is risky, because the loan falls due before the asset pays back.

The main sources are these:

Trade credit: suppliers let you pay later. It is spontaneous and often free if you pay within the credit period. A cash discount you give up has a real cost.
Bank overdraft: the bank lets a current account go below zero up to a sanctioned limit. Interest is charged only on the amount actually overdrawn, for the days used. It is repayable on demand.
Cash credit: a limit sanctioned against the security of stock and receivables (hypothecation or pledge). You draw and repay within the limit. Interest is on the amount used. It is the usual form of working capital loan for businesses.
Commercial paper (CP): an unsecured, short-term, negotiable money market instrument issued at a discount to face value and redeemed at par. Only large, creditworthy companies can issue it, as it needs a credit rating.
Factoring: you sell trade receivables to a factor, who advances a part of their value, may collect the debts and may bear the credit risk. Under recourse factoring the seller bears bad debt. Under non-recourse factoring the factor does.
Bill discounting: you sell a bill of exchange drawn on your customer to a bank before it matures. The bank pays the face value less a discount, and collects from the customer on the due date.

A key distinction for answers: overdraft is usually for temporary needs and is repayable on demand. Cash credit is for regular operating needs and is secured on current assets. Factoring is the sale of receivables, so it is not a loan on the books in the same way. Bill discounting needs a genuine trade bill. Factoring is also covered separately with forfaiting, which is for export receivables of a medium term.

CS exam answers should always add the compliance side: board approval of borrowing limits, Section 179 powers of the Board, and charge creation and registration where security is given.

Key rules to remember

Net working capital: Net working capital = Current assets − Current liabilities; Gross working capital means total current assets only.
Bill discounting proceeds: Proceeds = Face value − Discount, where Discount = Face value × Rate × (Days ÷ 365); Use the discount rate on face value unless the question says otherwise. Use 365 days unless told otherwise.
Commercial paper discount: Discount = Face value × Rate × (Days ÷ 365); Issue price = Face value − Discount; Effective yield is higher than the stated rate because interest is paid upfront.
Cost of giving up trade discount: Cost = [Discount % ÷ (100 − Discount %)] × [365 ÷ (Credit period − Discount period)] × 100; Shows when it pays to take the cash discount.
Factoring advance: Advance = Invoice value × Advance % ; Net = Advance − Factoring commission − Interest on advance; The balance is released when the customer pays or on the due date.
Overdraft or cash credit interest: Interest = Amount used × Rate × (Days used ÷ 365); Interest runs only on the amount actually drawn, not the full limit. A commitment fee on unused limit may apply.

How to solve Short-Term and Working Capital Finance questions

Use this method for theory and numerical questions on short-term sources.

1Read the facts: identify the need (temporary gap, regular operating cycle, receivables locked up) and who the borrower is (size, rating, security available).
2Name the working capital need and say whether it is permanent or temporary.
3List the suitable sources and give the feature of each: security, tenor, cost, who bears risk.
4For a numerical, pick the correct formula, note the days and rate basis, and compute the discount, interest or net proceeds in clear steps.
5Compare the options on cost, flexibility, security and effect on the balance sheet.
6Add compliance points: board resolution, borrowing limits, charge registration, rating needed for commercial paper.
7Conclude with a clear recommendation tied to the facts.

Quickest way: Match the need to the source

When to use it: Use when a case question asks which short-term source suits a company and you have little time.

Receivables stuck with customers: factoring or bill discounting.
Day-to-day running needs against stock: cash credit.
Short, temporary dip in a current account: overdraft.
Strong, rated, large company wanting cheap unsecured money: commercial paper.
Buying on credit from suppliers: trade credit.
Write two lines of reasons for the match, then one line on cost or risk.

Common mistakes in Short-Term and Working Capital Finance

Treating overdraft and cash credit as the same.
Both let you draw up to a limit and pay interest on use.
Fix: State the difference: overdraft is for temporary needs on a current account, often repayable on demand; cash credit is for regular needs against hypothecated stock and receivables.
Confusing factoring with bill discounting.
Both turn receivables into cash quickly.
Fix: Factoring covers a book of invoices and may include collection and credit protection. Bill discounting is the sale of a single bill of exchange to a bank.
Saying anyone can issue commercial paper.
It looks like a simple promissory instrument.
Fix: Say it is issued by companies that meet eligibility conditions set by the RBI, including a minimum credit rating and a minimum net worth. Do not quote exact limits unless you are certain.
Charging interest on the whole sanctioned limit.
Students mix up limit and amount drawn.
Fix: Compute interest only on the amount used and for the days used.
Wrong days or rate basis in discount problems.
Rushing and mixing 360 and 365 days.
Fix: Use the days given in the question; default to 365. Compute discount on face value.
Ignoring recourse in factoring.
Students focus only on cash advance.
Fix: Always say who bears the bad debt and show the effect on cost.

Worked examples

Example 1

Ananya Textiles Ltd holds a bill of exchange of ₹10,00,000 drawn on a customer, due in 90 days. It discounts the bill with a bank at 12% per annum. Find the discount and the cash received. Use a 365-day year.

Show the solution

Face value = ₹10,00,000; rate = 12%; days = 90.
Discount = 10,00,000 × 12% × 90 ÷ 365.
10,00,000 × 0.12 = ₹1,20,000 per year.
1,20,000 × 90 ÷ 365 = 1,08,00,000 ÷ 365 = ₹29,589 (rounded).
Cash received = 10,00,000 − 29,589 = ₹9,70,411.
The bank collects ₹10,00,000 from the customer on the due date.

Answer: Discount is about ₹29,589 and Ananya Textiles receives about ₹9,70,411 now.

Example 2

Kaveri Foods Ltd has an annual credit sale of which an invoice of ₹5,00,000 is factored with recourse. The factor advances 80% of the invoice, charges commission of 2% on the invoice value, and charges interest at 10% per annum on the advance for 60 days. Compute the net cash received on day one. Use a 365-day year.

Show the solution

Advance = 80% × 5,00,000 = ₹4,00,000.
Commission = 2% × 5,00,000 = ₹10,000.
Interest = 4,00,000 × 10% × 60 ÷ 365 = 40,000 × 60 ÷ 365.
40,000 × 60 = 24,00,000; ÷ 365 = ₹6,575 (rounded).
Net cash = 4,00,000 − 10,000 − 6,575 = ₹3,83,425.
Because it is with recourse, Kaveri Foods still bears the bad debt if the customer does not pay.

Answer: Net cash received is about ₹3,83,425. The balance 20% is released on collection, less any dues.

Exam tips

Write the source name, then definition, features, advantage and limitation. This structure scores in descriptive answers.
Always give a one-line difference when two sources look alike, such as overdraft and cash credit or factoring and forfaiting.
In numerical parts, show the formula, the days and the rate before calculating.
Link the answer to the company's facts and add one compliance point such as board approval or charge registration.
For commercial paper, mention rating, unsecured nature, discount issue and redemption at face value.

Practice questions from Sources of Corporate Funding

Short-Term and 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.

Short-Term and Working Capital Finance: frequently asked questions

What are the main sources of working capital finance?

Trade credit, bank overdraft, cash credit, commercial paper, factoring and bill discounting are the main short-term sources. Banks and suppliers are the most common providers. Choose based on need, size, security and cost.

What is the difference between cash credit and overdraft?

Cash credit is a limit against hypothecated or pledged stock and receivables, used for regular operating needs. Overdraft lets a current account go negative up to a limit, usually for temporary needs, and may be repayable on demand. Interest in both is on the amount used.

What is commercial paper?

It is an unsecured, negotiable money market instrument issued at a discount and redeemed at face value. Only creditworthy companies that meet RBI eligibility conditions, including a credit rating, can issue it. It suits large companies seeking cheaper short-term funds.

How does bill discounting work?

The seller draws a bill on the buyer and sells it to a bank before maturity. The bank pays face value less a discount and collects the full amount from the buyer on the due date.

What is the difference between factoring and forfaiting?

Factoring deals with short-term trade receivables, domestic or export, and may include collection and credit services. Forfaiting is the purchase of medium-term export receivables without recourse to the exporter, usually backed by a bank guarantee. Study it with the related topic on factoring and forfaiting.