Traditional Approach

‘The traditional approach to the scope of financial management refers to its subject-matter, in academic literature in the initial stages of its evolution. as a separate branch of academic study. The term ‘corporation finance’ was used to describe what is now known in the academic world as ‘financial management’. As the name suggests, the concern of corporation finance was with the financing of corporate enterprises. In other words, the scope of the financial function was treated by the traditional approach in the narrow sense of procurement of funds by corporate enterprise to meet their financing needs. The term ‘procurement’ was used in a broad sense so as to include the whole gamut of raising funds externally. Thus defined. the field of study dealing with finance was treated as encompassing three interrelated aspects of raising and administering resources from outside: (i) the institutional arrangement in the form of financial institutions which comprise the organisation of the capital market; (ii) the financial instruments through which funds are raised from the capital markets and the related aspects of practices and the procedural aspects of capital markets: and (iii) the legal and accounting relationships between a firm and its sources-of funds. The coverage of corporation finance was, therefore, conceived to describe the rapidly evolving complex of capital market institutions, instruments and practices. A related aspect was that firms require funds at certain episodic events such as merger, liquidation, reorganization and so on. A detailed description of these major events constituted the second element of the scope of this field of academic study. That these were the broad features of the subject-matter of corporation finance is eloquently reflected in the academic writings around the. period during which the traditional approach dominated academic thinking. I Thus, the issues to which literature on finance addressed itself was how resources could best be raised from the combination of the available sources.

The traditional approach to the scope of the finance function evolved during the 19205 and 1.9305 and dominated academic thinking during the forties arid through the early fifties. It has now been discarded as it suffers from serious limitations. The weaknesses of the traditional approach fall into two. broad categories: (i) those relating to the treatment of various topics and the emphasis attached to them and (ii) those relating to the basic conceptual and analytically framework of the definitions and scope of the finance function.

The first argument against the traditional approach was based on its emphasis on issues relating to the procurement of funds by corporate enterprises. This approach was challenged during the period when the approach dominated the scene itself. Further. the traditional treatment of finance was criticized because the equated with the issue in realizing and administering funds, the theme was woven around the viewpoint of the suppliers of funds such : I investors, investment bankers and so on, that is the outsiders. It implies that no consideration, was given to viewpoint of those who had to take internal financial decisions. The traditional treatment was. in other words, the outsider looking-in approach. The limitation was that internal decision making (i,e. insider-looking-out) was completely ignored .

The second ground of criticism of the traditional treatment was that the focus was on financing problems of corporate enterprise. To that extent the scope of financial management was confined only to a segment of the industrial enterprises, as non-corporate organisations lay. outside its scope.

Yet another basis on which the traditional approach was challenged was that the treatment was built too closely around episodic events, such as promotion, incorporation. merger, consolidation. reorganization and so on. Financial management was confined to a description of these infrequent
happenings in the life of an enterprise. As a logical corollary, the day-to-day financial problems of a normal company did not receive much attention.

Finally, the traditional treatment was found to have a lacuna to the extent that the focus was on long-term financing. Its natural implication was that the issues involved in working capital management were not in the purview of the finance function.

The limitations of the traditional approach were not entirely based on treatment or emphasis of different aspects, In other words, its weaknesses were more fundamental. The conceptual and analytically shortcoming of this approach arose from the fact that it-confined financial management to issues involved in procurement of external funds, it did not consider the important dimension of allocation of capital. The conceptual framework of the traditional treatment ignored what Solomon aptly described as the central issues of financial management. These issues were reflective in the following fundamental questions which a finance manager should address. Should an enterprise commit capital funds to certain purposes? Do the expected returns meet financial standards of performance? How should these standards be set and what is the COS!of capital funds 10 the enterprises? How does the cos vary with the mixture of finding methods used? In the absence of the coverage of these crucial aspects, the traditional approach implied a very narrow scope for financial management. The modem approach provides a solution to these shortcomings.

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