- Oct 09, 2019
The Traditional Approach and The Modern Approach of Finance
- Feb 22, 2019
- 3236 views
A number of approaches are associated with finance function but for the sake of convenience, various approaches are divided into two broad categories:
1. The Traditional Approach
2. The Modern Approach
The traditional approach to the finance function relates to the initial stages of its evolution during 1920s and 1930s when the term ‘corporation finance’ was used to describe what is known in the academic world today as the ‘financial management’. According to this approach, the scope, of finance function was confined to only procurement of funds needed by a business on most suitable terms.
The utilisation of funds was considered beyond the purview of finance function. It was felt that decisions regarding the application of funds are taken somewhere else in the organisation. However, institutions and instruments for raising funds were considered to be a part of finance function.
The scope of the finance function, thus, revolved around the study of rapidly growing capital market institutions, instruments and practices involved in raising of external funds.
The traditional approach to the scope and functions of finance has now been discarded as it suffers from many serious limitations:
(i) It is outsider-looking in approach that completely ignores internal decision making as to the proper utilisation of funds.
(ii) The focus of traditional approach was on procurement of long-term funds. Thus, it ignored the important issue of working capital finance and management.
(iii) The issue of allocation of funds, which is so important today, is completely ignored.
(iv) It does not lay focus on day to day financial problems of an organisation.
2. The Modern Approach:
The modern approach views finance function in broader sense. It includes both rising of funds as well as their effective utilisation under the purview of finance. The finance function does not stop only by finding out sources of raising enough funds; their proper utilisation is also to be considered. The cost of raising funds and the returns from their use should be compared.
The funds raised should be able to give more returns than the costs involved in procuring them. The utilisation of funds requires decision making. Finance has to be considered as an integral part of overall management. So finance functions, according to this approach, covers financial planning, rising of funds, allocation of funds, financial control etc.
The new approach is an analytical way of dealing with financial problems of a firm. The techniques of models, mathematical programming, simulations and financial engineering are used in financial management to solve complex problems of present day finance.
The modern approach considers the three basic management decisions, i.e., investment decisions, financing decisions and dividend decisions within the scope of finance function.
March 2018 finance report:
2018 started with the good news. The World Bank’s Global Economic Prospects and the IMF’s World Economic Outlook both show that the global economy is in a recovery. Furthermore, it is expected that the upturn is broad-based as the growth is increasing in more than half of the world economies growth in 2017 is estimated to have rebounded to 2.3 percent while emerging and developing economies (EMDEs) were projected to have higher-than-expected growth of 4.3 percent. Overall, global growth is projected to edge up to 3.1 percent in 2018.
Uncertainty remains elevated due to other factors such as the consequences of Brexit, possible changes to trade policies in US, and the concerns due to the increasing political tension in Middle East. In the end, financial markets are functioning but vulnerable, as the recent IIF report shows that EMDEs portfolio outflows in February 2018 were the sharpest since the US Presidential election.
However,Some sources of finance are short term and must be paid back within a year. Other sources of finance are long term and can be paid back over many years. Internal sources of finance are funds found inside the business. For example, profits can be kept back to finance expansion.