Sources of Working Capital

Sources of working capital can be spontaneous, short term and long term. Spontaneous working capital includes mainly trade credit such as the sundry creditor, bills payable, and notes payable. Short term sources are tax provisions, dividend provisions, bank overdraft, cash credit, trade deposits, public deposits, bills discounting, short term loans, inter-corporate loans, and commercial paper. Long term sources are retained profits, provision for depreciation, share capital, long-term loans, and debentures.

Spontaneous Sources Short Term Sources Long Term Sources
Internal Sources External Sources Internal Sources External Sources
Trade Credit Tax Provisions Bank Overdraft Retained Profits Share Capital
Sundry Creditors Dividend Provisions Trade Deposits Depreciation Provision Long Term Loans
Bills Payable   Public Deposits   Debentures
Notes Payable   Bills Discounting    
 Accrued Expenses   Short Term Loans    

Spontaneous Sources of Working Capital Finance

The word ‘spontaneous’ itself explains that this source of working capital is readily or easily available to the business in the normal course of business affairs. The quantum and terms of this credit depend on the industry norms and relationship between buyer and seller. These sources include trade credit allowed by the sundry creditors, credit from employees, and other trade-related credits. The biggest benefit of spontaneous sources as working capital is its effortless raising and insignificant cost compared to traditional ways of financing.

The cost factor and the quantum depends a lot on the terms of such credit viz. maximum credit limit, the period of credit, and discount on cash payment. Each supplier will have a maximum credit limit defined for the buyer depending on the business capacity and creditworthiness of the buyer. Similarly, the credit period is defined say 30 days, 45 days etc. Discount on cash payment is allowed to the buyer if the payment immediately on buying the materials. This percentage of discount is an opportunity cost for the buyer.

Short Term Sources of Working Capital Finance

Short term sources can be further divided into internal and external sources of working capital finance. The short-term internal sources include tax provisions, dividend provisions etc. Short-term external sources include short-term working capital financing from banks such as bank overdrafts, cash credits, trade deposits, bills discounting, short-term loans, inter-corporate loans, commercial paper, etc.

Tax and dividend provisions are current liabilities and cannot be delayed. The fund that would have been used in paying these provisions act as working capital till the point these are not paid.

Short term working capital finance availed from banks and financial institutions are costly compared to spontaneous and long-term sources in terms of rate of interest but have a great time flexibility. Due to time flexibility, the finance manager can use the funds and pay interest on the money which his business utilizes and can pay them anytime when cash is available. Overall, in comparison to long term sources where you have to hold funds even when not required, these facilities proves cheaper.

Long Term Sources of Working Capital Financing

Long term sources can also be divided into internal and external sources. Long term internal sources of finance are retained profits and provision for depreciation whereas external sources are Share Capital, long-term loan, and debentures.

Retained profits and accumulated depreciation are as good as funds available to the business without any explicit cost. These are the funds completely earned and owned by the business itself. They are utilized for expansion as well as working capital finance. Long-term external sources of finance like share capital is a cheaper source of finance but are not commonly used for working capital finance.

Working capital can be classified into temporary working capital and permanent working capital. It is advisable to use long term sources for permanent and short-term sources for temporary working capital requirements. This will optimize the working capital cost and enforce good working capital management practices.

Last updated on : July 12th, 2017
What’s your view on this? Share it in comments below.

No Responses

  1. Pingback:

Leave a Reply

Working Capital Estimation – Operating Cycle Method
  • Intersection of Carrying Cost and Shortage Cost
    Techniques for Finding Optimal Level of Working …
  • Advantages and Disadvantages of Invoice Discounting
    Advantages and Disadvantages of Invoice Discounting
  • Packing Credit
    Packing Credit
  • Bank Overdraft Facility
  • Subscribe to Blog via Email

    Enter your email address to subscribe to this blog and receive notifications of new posts by email.

    Join 122 other subscribers

    Recent Posts

    Find us on Facebook


    Related pages


    formula to calculate debt ratioresidual dividend model exampledebt service coverage ratio calculatorwhat is capm in financial managementdifference between stockholders and stakeholderstermination of hire purchase agreementoptimal capital budget definitionstockholder shareholder stakeholderformula to calculate operating profitwhat is eoq in inventory managementrelevant cost managerial accountingliquid asset ratio formulacapital rationing calculatorformula for internal rate of returnoverdraft limit definitionwhat is payback methodebit vs net incomewhat does total asset turnover meanpurpose of managerial accountinggdr countrydefine debenture bondyield to maturity formula exampledisadvantages of break even analysisstartup funding rounds explainedwip calculationzbb zero based budgetingwhat accounts have a normal debit balanceinternal rate of return irr formulameaning of ladingdebtor turnover formulaliquidity quick ratiomv equitydebtors velocityinterpreting earnings per sharemeaning of current assets and current liabilitiescalculate average collection periodar turnover calculationwhat is the difference between multinational and international companiescommon size statement value of inventory formulaliquidity ratio formulaslabour costing in cost accountingrent vs lease definitionnpv investment appraisalhow to calculate debtors turnover ratioinvestment in debenturesirrevocable letter of credit at sightdefinition of owner's equitytotal inventoriable product costlessees and lessorsoperating leases differ from capital leases in thattobin theorycash turnover formulamultiple irr calculatordirect relationship vs indirect relationshipsignificance of capital budgetinghow to calculate roaus gaap r&dfixed asset impairment testfactoring as a source of financedebit definition accountingdefinition of irrelevancedividend formula financeprofitability index example problemsfinance payback periodlc discounting chargesdistinguish management accounting from financial accountinghow to calculate inventory turnover daysover draft definitioncapitalizing expendituresreceivables turnover ratio definitioninterpretation of fixed asset turnover ratiodividend discount modelinventory days calculation formulaebit calculation formulabest capital budgeting method