Comprehensive University Study Notes on Business Finance, Financial Markets, and Analysis

The Financial Function and Business Finance Cores

The financial function within a company involves observing how money enters the enterprise, how it is utilized, and how it exits. Business finance is fundamentally structured around three core areas. The first is Financial Management, which encompasses the management of working capital, capital budgeting, and the financial management of multinational companies. The second core is Investment and Risk Analysis, which focuses on investment analysis, portfolio management, derivatives, and financial engineering. The third core involves Financial Markets and Institutions, covering the money and capital markets, commercial banking, and investment banking.

From a managerial perspective, finance is viewed as a concept comprising the financial environment, financial instruments, and the financial manager. The financial environment includes financial markets where lenders and investors provide capital, as well as markets for goods and services where resources are acquired and products are sold. This environment also includes the tax system, which determines income distribution to state institutions and subsequent redistribution. Financial instruments are legal contracts giving owners (investors) the right to participate in the company's business results. These include bank loan contracts and transferable securities, such as shares and bonds. The Financial Manager is responsible for the funds entering, circulating within, and exiting the company. This individual must possess detailed knowledge of cash flows to ensure that money is used in the most optimal way.

External Financial Reporting Frameworks

Financial reporting is the method by which a company communicates its performance and position. The Income Statement (Bilans uspeha) is a report showing revenues, expenses, and the operating result over a specific period. It is often referred to as the earnings report or the profit and loss statement. The difference between total revenues (PH) and total expenses (RH) for the period constitute the net profit (PF) or net loss. This statement is typically divided into operational, financial, and non-operational sections. Daily business transactions are reported in the operational segment, while the financial section covers interest income and expenses. The non-operational section relates to marginal items that are routine but not part of daily core operations.

The Balance Sheet (Bilans stanja) is a static report showing how a company manages its assets and the sources of those assets at a specific moment in time, known as the balancing date. It displays the state of assets on one side and capital and liabilities on the other. Assets (Sredstva) represent investments, while liabilities and capital represent the sources of those investments. Assets are usually listed in order of increasing liquidity, starting from fixed (osnovna) assets to current (obrtna) assets. Fixed assets include tangible (land, buildings, vehicles, equipment), intangible (patents, rights, trademarks, goodwill), and financial assets (long-term securities and deposits) intended for use longer than one year. Current assets include inventories, short-term securities (maturity under one year), accounts receivable (uncollected sales), and the most liquid part, cash and cash equivalents. Capital represents ownership in the company (share capital in corporations). Liabilities are divided into long-term (over one year, such as long-term loans) and short-term (due within a year, such as obligations to suppliers and employees). Items are typically valued at historical (past) cost, though market values may differ due to inflation or market changes.

The Cash Flow Statement (Izveštaj o tokovima gotovine) summarizes changes in cash movement over a period and can be prepared using two methods. The Direct Method (top-down) tracks gross cash flows by linking specific revenues and expenses to their corresponding inflows and outflows; it is preferred for internal planning but is more complex. The Indirect Method (bottom-up) starts with net income and adjusts for non-cash items and changes in balance sheet accounts. The report consists of three segments: Operating Activities (cash from sales, wages, interest), Investing Activities (purchase or sale of fixed assets and other companies), and Financing Activities (structural transactions related to capital, such as loans or equity changes). The difference between total inflows and outflows is the Net Cash Flow. Finally, the Statement of Changes in Equity (Izveštaj o promenama na kapitalu) is intended for owners, showing net profit/loss and the effects of changes on the initial capital state.

Financial Management Systems and Agency Theory

Financial management, as part of total management, involves directing, regulating, and changing financial flows to maximize the achievement of economic and social goals. The specific financial goals include maintaining an optimal structure of assets and sources, ensuring liquidity and solvency, rational investment, financial stability, minimizing costs while maximizing revenues, and increasing assets. Broad company goals include profit maximization, maximizing profitability (return on investment), survival, long-term stability, growth, and maximizing shareholder satisfaction. The primary financial processes are determining the need for funds, acquiring funds, using the funds, and monitoring/controlling them.

A significant issue in corporate governance is the conflict of interest between shareholders and managers, known as the Principal-Agent relationship. Shareholders (principals) set the management, while managers (agents) run the daily operations. Ideally, managers should work in the shareholders' interest, but they often prioritize their own interests, leading to suboptimal decisions. This creates the "Agency Problem," which results in Agency Costs. These costs are incurred to align management's decisions with shareholder interests, such as monitoring costs or the payment of bonuses and stock options to managers.

Business Organizational Forms and Financial Policy

Companies can take one of three main organizational forms. The Sole Proprietorship (Preduzeće u vlasništvu pojedinca) is the oldest form where one person owns all assets and profits but is personally liable with their own capital for all debts. It is easy to found with low costs but lacks flexibility in capital acquisition. A Partnership (Ortakluk) involves multiple owners who are jointly and severally liable for all obligations. A Limited Liability Partnership includes at least one general partner with unlimited liability and limited partners who only risk their invested capital. The Company/Corporation (Kompanija) is the model for large enterprises, characterized by limited liability, where ownership is evidenced by shares and is easily transferable. Its life is not limited by the owner's lifespan, though it faces the disadvantage of double taxation on profits and dividends.

Financial policy can be categorized from different aspects. Genetically and temporally, it includes financing policy, investment policy, and current financial policy. From a time aspect, it is divided into long-term structure policy and short-term liquidity policy. Internal factors affecting financial policy include global business policy, development plans, and capacity utilization. External factors are more significant, primarily the Economic System (the "forced environment") and the Market (the "relatively limiting factor"). The market includes segments like the buyer market, supplier market, foreign exchange market, and money and capital markets.

The Monetary-Credit and Foreign Exchange System

The economic system provides the institutional environment for a firm and includes subsystems like the monetary-credit, foreign exchange, tax, banking, foreign trade, and customs systems. Monetary-credit policy regulates the level, structure, and dynamics of the money supply and interest rates using several instruments: 1. Discount Rate (Eskontna stopa) - the rate Central Banks charge commercial banks; 2. Interest Rates - used to conduct expansive or restrictive policy depending on inflation; 3. Reserve Requirement (Stopa obavezne rezerve) - a percentage of deposits banks must keep with the Central Bank; 4. Liquidity Reserve Rate - set by banks themselves; 5. Calculation base for reserves; 6. Selective rediscount credits; and 7. Open market policy.

The money supply is an indicator of national liquidity. If it grows faster than the nominal social product, policy is expansive; if slower, it is restrictive. Inflation is a monetary phenomenon where the money supply grows faster than production, leading to price increases and reduced purchasing power. Its consequences include irrational consumption, "flight" of savings into assets, and increased debt. Deflation is the opposite, where the money supply is smaller than goods funds, leading to falling prices and increased money value. Appreciation is an increase in currency value, while depreciation is a decrease.

The Foreign Exchange System regulates relations between domestic and foreign entities, exchange rates, and reserves. "Devize" (Foreign Exchange) includes all claims abroad in any currency (checks, bills, etc.), while "Valuta" refers only to effective foreign paper or coin money. Convertibility types include external (foreign entities can swap claims), internal (only domestic entities can), general, and unlimited/limited. Exchange rates (Devizni kurs) express foreign currency prices in domestic units and can be Fixed (fluctuation within $2.25\%$), Flexible (wider ranges), Fluctuating/Floating (determined by supply and demand), or Multiple (different rates for exports and imports). The exchange rate list (Lista kurseva) shows these values relative to the national currency.

The Banking System and Credit Varieties

A bank is a financial intermediary that collects free funds and places them through loans or securities purchases. Banks can act in their own name, for a partner, or for a principal. Banks are categorized as Universal, Commercial (deposit-taking), Investment (securities trading), Mortgage, Savings, Cooperative, Merchant, International, or State banks. The Central Bank (National Bank of Serbia) is the executive organ of monetary policy. Its main goal is price stability and managing the money supply. It issues currency, determines monetary and FX policy, manages reserves, and issues licenses to financial institutions.

Banking operations are divided into several types based on the balance sheet:

1. Active Operations: The bank is a creditor. It places funds through loans and charges an Active Interest Rate ($Aktivna\,kamatna\,stopa$). These include short-term and long-term credits.
2. Passive Operations: The bank is a debtor. It collects funds and pays a Passive Interest Rate ($Pasivna\,kamatna\,stopa$). These include deposits, interbank loans, rediscount (reeskontni) operations, and issuing securities.
3. Neutral Operations: The bank acts as a commission agent (safe contracts, FX transactions, domestic clearing, and bank guarantees).
4. Own Operations: The bank takes initiative for its own account, such as arbitrage (buying cheap on one market and selling dear on another) or equity participation.

Specific credit types include:

• Discount (Eskontni) Credit: Buying a claim before maturity.
• Acceptance (Akceptni) Credit: The bank accepts a bill of exchange, providing its reputation rather than funds.
• Aval or Caution Credit: The bank provides a guarantee for the user toward a third party.
• Current Account (Konto-korentni) Credit: Clearing mutual claims between companies at the end of a period.
• Lombard Credit: Loans secured by movable property.
• Mortgage (Hipotekarni) Credit: Loans secured by real estate.
• Revolving Credit: Automatically renewing credit amounts.
• Rambusni Credit: A special acceptance credit for maritime trade.

Financial Markets and Transferable Instruments

Financial markets are where supply and demand for financial resources meet. They are divided by maturity into the Money Market (short-term, under 1 year, trading in "ready money" or žiralni novac) and the Capital Market (long-term, over 1 year, trading in capital and effects). They are also divided into Primary (new emissions) and Secondary (resale of existing securities). Secondary markets involve Brokers (agents for others) and Dealers (trading for their own account) and can be informal or organized exchanges (Berze) using auction principles.

Financial instruments include:

1. Transferable Securities: Shares (akcije) and bonds (obveznice).
2. Money Market Instruments: Treasury bills, commercial paper.
3. Derivatives: Standardized contracts for future transfers.    - Forwards: Basic future contracts for non-present goods.    - Futures: Complex exchange-traded future contracts requiring initial margins.    - Options: The right, but not obligation, to buy (Call) or sell (Put) an asset for a premium.    - Swaps: Exchange of obligations, usually interest rates or currencies, often facilitated by a Swap Dealer.

Bills of Exchange (Menica) are formal documents where one party promises to pay a sum. Essential elements include the tag "bill of exchange," unconditional payment order, name of drawer (trasant), drawee (trasat), payee (remitent), maturity, and place of issue. Actions include acceptance (drawee confirms), avaling (guaranteeing), and endorsing (transferring rights). Checks (Ček) are payment instruments (not credit instruments) payable on sight and requiring existing coverage. Other instruments include Bills of Lading (Tovarni list), Warehouse Receipts (Skladišnica), and Bonds (Obveznice), which represent a loan and provide interest (ordinary) or profit share (participative). Shares (Akcije) represent ownership equity and provide rights to dividends, management, and liquidation proceeds. Preferred shares (povlašćene) have dividend priority but usually no voting rights.

Financial Planning, Budgeting, and Performance Analysis

Planning is a process, and the plan is the result. Planning philosophies include Satisfactory (modest goals based on the past), Optimal (balancing costs and benefits), and Innovative (adaptive strategies for uncertainty). Financial planning includes Profit Planning (pro forma income statements), Short-term Planning (cash budgets), and Long-term Planning (growth needs). Budgeting is the translation of strategic plans into measurable action plans. A Master Budget includes an Operational component (physical product and factors) and a Financial component (pro forma balance sheet and cash budget).

Financial Analysis uses numerical data to assess performance. It differentiates between Ex Post (past) and Ex Ante (future/perspective) analysis. Tools include Absolute numbers, Horizontal (trend) analysis, Vertical analysis, and Ratio analysis. Ratios are compared against internal norms (historical/anticipative) or external norms (competitors).

Liquidity Ratios measure short-term debt coverage:

1. General Liquidity Ratio ($ORL$): $ORL = \frac{\text{Obrtna sredstva}}{\text{Kratkoročne obaveze}}$ (Rule of thumb: $2:1$).
2. Quick Ratio ($BRL$): $BRL = \frac{\text{Obrtna sredstva} - \text{Zalihe} - \text{AVR}}{\text{Kratkoročne obaveze}}$ (Rule of thumb: $1:1$).
3. Net Working Capital ($NOS$): $NOS = \text{Obrtna sredstva} - \text{Kratkoročne obaveze}$

Activity Ratios (Turnover) measure efficiency:

• Inventory Turnover ($KOZ$): $KOZ = \frac{\text{Cena koštanja prodatog}}{\text{Prosečne zalihe}}$
• Receivables Collection Period: $\frac{360}{KOK}$

Financial Structure, Profitability, and Risk

Financial Structure analysis focuses on the mix of own and borrowed capital (Leverage). The debt-to-equity ratio measures the burden on each unit of capital. Creditworthiness is assessed via the Interest Coverage Ratio: $\text{Interest Coverage} = \frac{\text{EBIT}}{\text{Interest Expense}}$

Profitability Ratios:

• EBIT Margin: $\frac{\text{EBIT}}{\text{Net Revenue}}$
• Return on Assets ($ROA$): $\frac{\text{EBIT}}{\text{Total Assets}}$
• Return on Equity ($ROE$): $\frac{\text{Net Profit}}{\text{Own Capital}}$ DuPont Analysis breaks down profit sources: $\text{SPSS} = \frac{\text{Net Profit}}{\text{Net Revenue}} \times \frac{\text{Net Revenue}}{\text{Assets}} \times \frac{\text{Assets}}{\text{Equity}}$

Risk results from uncertainty and fixed costs.

• Business Leverage Factor ($FL_{posl}$): $FL_{posl} = \frac{\text{Marginal Profit}}{\text{Operating Profit (EBIT)}}$ If $FL_{posl} = 4.2$, a $1\%$ revenue change results in a $4.2\%$ EBIT change.
• Financial Leverage Factor ($FL_{fin}$): $FL_{fin} = \frac{\text{Operating Profit}}{\text{Profit Before Tax}}$
• Total Leverage Factor ($TL$): $TL = FL_{posl} \times FL_{fin}$