What is Traditional approach of financial management? Limitation of Traditional approach of financial management.

Traditional approach of financial management

Traditional-approach-of-financial-management

Traditional Approach of Financial Management: The traditional approach, which was popular in the early stages, limited the role of the financial manager to raising and managing the funds needed by the business enterprises to meet their financial needs. The traditional approach of financial management is an old-fashioned way of looking at the financial part of a business. It focuses heavily on how to raise funds from different sources, such as stock, debt, banks, etc. It does not pay much attention to how the funds are used or divided within the business.

  • Traditional approach of financial management deals with the following aspects:

i) Arrangement of funds from banking companies
ii) Arrangement of funds through financial tools like shares, bonds, etc.

iii) Looking after the legal and accounting link between a corporation and its sources of funds Thus, the financial manager had a limited job to perform. He was expected to keep correct financial records, prepare reports on the corporation’s state and performance, and manage cash in such a way that the corporation was in a position to pay its bills in times of need.

Limitation of Traditional approach of financial management

The term corporate Finance’ was used in place of the present word financial Management’. The traditional approach to the scope of the finance function emerged during the 1920s and 1930s and ruled academic thinking during the forties and through the early fifties. It has now been discarded as it suffers from major limitations. Following are the main limitations:

a) External method: The method treated the subject of finance only from the point of view of sources of funds, i.e., outsiders, viz., bankers, investors, etc. It took an outsider-looking-in approach and not an insider-looking-out approach. Since it completely ignored the point of view of those who had to make internal funding choices.

b) Ignored everyday problems: The subject of financial management was mainly confined to the financial problems arising during the course of incorporation, mergers, etc., and the subject did not give any value to day-to-day financial issues of businesses.

c) Ignored non-corporate enterprises: The method focused mainly on the financial problems of corporate businesses.

d) Ignored working capital financing: The problems related to financing short-term or working capital were ignored in the method. The approach focuses mainly on issues of long-term financing.

e) No Emphasis on Allocation of Funds: The method limited financial management only to the purchase of funds. It did not stress the allocation of cash.

Other limitation of traditional approach of financial management:

It is one-sided and small. It only considers the procurement of funds and not their successful usage.

  • It is limited to the business sector.
  • It does not handle the financial problems of other types of organizations, such as non-profits, governments, or small businesses.
  • It is focused on unusual events.
  • It is old and useless.
  • It does not represent the current and dynamic business world or the technological advances in the area of finance.

The conceptual structure of the traditional treatment ignored what Solomon accurately describes as the core problems of financial management. These are:

i) Should a company commit financial funds to certain purposes?
ii) Do the expected returns meet financial standards of performance?

iii) How should these standards be set, and what is the cost of capital funds to the enterprise?iv) How does the cost change with the mixture of financing options used?

Due to the lack of coverage of these crucial aspects, the standard method suggests a very narrow scope for financial management. The modern method offers an answer to these shortcomings. The traditional approach of financial management was followed until the mid-20th century, when it was replaced by the modern method. The modern method is more thorough, analytical, and scientific. It views finance as an important part of overall management. It stresses the best use of funds and the maximization of shareholders’ wealth.

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