diff --git a/__tests__/utils.test.ts b/__tests__/utils.test.ts
index 30fc61cb..7722fb35 100644
--- a/__tests__/utils.test.ts
+++ b/__tests__/utils.test.ts
@@ -1,6 +1,7 @@
 import * as cache from '@actions/cache';
 import * as core from '@actions/core';
 import {
+  parsePythonVersionFile,
   validateVersion,
   validatePythonVersionFormatForPyPy,
   isCacheFeatureAvailable
@@ -9,6 +10,20 @@ import {
 jest.mock('@actions/cache');
 jest.mock('@actions/core');
 
+describe('parsePythonVersionFile', () => {
+  it('handle the content of a .python-version file', () => {
+    expect(parsePythonVersionFile('3.6')).toEqual('3.6')
+  });
+
+  it('trims extra spaces at the end of the content', () => {
+    expect(parsePythonVersionFile('3.7   ')).toEqual('3.7')
+  });
+
+  it('parses correctly the content of .tool-version files', () => {
+    expect(parsePythonVersionFile('python 3.7')).toEqual('3.7')
+  });
+});
+
 describe('validatePythonVersionFormatForPyPy', () => {
   it.each([
     ['3.6', true],
diff --git a/docs/advanced-usage.md b/docs/advanced-usage.md
index 1483da99..718a4f5a 100644
--- a/docs/advanced-usage.md
+++ b/docs/advanced-usage.md
@@ -239,9 +239,10 @@ jobs:
 
 ## Using the `python-version-file` input
 
-`setup-python` action can read Python or PyPy version from a version file. `python-version-file` input is used for specifying the path to the version file. If the file that was supplied to `python-version-file` input doesn't exist, the action will fail with error.
+The python-version-file input accepts a path to a file containing the version of Python to be used by a project, for example .python-version, or .tool-versions. 
+If both the python-version and the python-version-file inputs are provided then the python-version input is used. 
 
->In case both `python-version` and `python-version-file` inputs are supplied, the `python-version-file` input will be ignored due to its lower priority.
+> The action will search for the python version file relative to the repository root.
 
 ```yaml
 steps:
diff --git a/src/setup-python.ts b/src/setup-python.ts
index 7e9725e1..1ef75060 100644
--- a/src/setup-python.ts
+++ b/src/setup-python.ts
@@ -5,7 +5,7 @@ import * as path from 'path';
 import * as os from 'os';
 import fs from 'fs';
 import {getCacheDistributor} from './cache-distributions/cache-factory';
-import {isCacheFeatureAvailable, logWarning, IS_MAC} from './utils';
+import {parsePythonVersionFile, isCacheFeatureAvailable, logWarning, IS_MAC} from './utils';
 
 function isPyPyVersion(versionSpec: string) {
   return versionSpec.startsWith('pypy');
@@ -37,20 +37,29 @@ function resolveVersionInput() {
   }
 
   if (versionFile) {
-    if (!fs.existsSync(versionFile)) {
+    const versionFilePath = path.join(
+      process.env.GITHUB_WORKSPACE!,
+      versionFile
+    );
+
+    if (!fs.existsSync(versionFilePath)) {
       throw new Error(
-        `The specified python version file at: ${versionFile} doesn't exist.`
+        `The specified python version file at: ${versionFilePath} doesn't exist.`
       );
     }
-    const version = fs.readFileSync(versionFile, 'utf8');
+
+    const version = parsePythonVersionFile(fs.readFileSync(versionFilePath, 'utf8'));
     core.info(`Resolved ${versionFile} as ${version}`);
+
     return [version];
   }
 
   logWarning(
     "Neither 'python-version' nor 'python-version-file' inputs were supplied. Attempting to find '.python-version' file."
   );
+
   versionFile = '.python-version';
+
   if (fs.existsSync(versionFile)) {
     const version = fs.readFileSync(versionFile, 'utf8');
     core.info(`Resolved ${versionFile} as ${version}`);
diff --git a/src/utils.ts b/src/utils.ts
index 5a5866ea..9d5f2312 100644
--- a/src/utils.ts
+++ b/src/utils.ts
@@ -28,6 +28,22 @@ export interface IPyPyManifestRelease {
   files: IPyPyManifestAsset[];
 }
 
+export function parsePythonVersionFile(contents: string): string {
+  let pythonVersion: string | undefined;
+
+  // Try to find the version in tool-version file
+  const found = contents.match(/^(?:python\s+)?v?(?<version>[^\s]+)$/m);
+  pythonVersion = found?.groups?.version;
+
+  // In the case of an unknown format,
+  // return as is and evaluate the version separately.
+  if (!pythonVersion) {
+    pythonVersion = contents.trim();
+  }
+
+  return pythonVersion as string;
+}
+
 /** create Symlinks for downloaded PyPy
  *  It should be executed only for downloaded versions in runtime, because
  *  toolcache versions have this setup.