FIN500MOOC1MOD2

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Preface
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made from Module 2 of Professor Xi Yang's Introduction to Finance:
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Copyright © 2020 by Xi Yang
All rights reserved.
Published by the Gies College of Business at the University of Illinois

at Urbana-Champaign, and the Board of Trustees of the University of
Illinois
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Module 2 Introduction to
Finance: The Basics
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Module 2 Overview
Module 2 Overview
Media Player for Video
Introduction - Slide 1
Transcript
In this module will learn the basics of financial statements. In order to

help you understand the importance of financial statements, I want
you to think about a daily example.
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Parent Example - Slide 2
Transcript
Suppose you are a parent of a high school student and you are
curious about your student's academic performance in school. One
way is to take a look at their transcript. It is an official document that
summarizes a students coursework and grades. The transcripts will
also be used in their college applications, scholarship applications
and others. Financial statements can be thought of as a transcript for
a company. There are official documents that summarize the
financial performance of the company. Financial statements are used
by investors, creditors, researchers and anyone who is interested in
the company. You need some basic knowledge to read a student's
transcript. What are the classes? Are the easy classes or hard
classes? What is the credit assigned to each class and what do the
grades stand for? Follow the same logic. You also need to know
some basic knowledge in order to read financial statements.
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Three Basic Financial Statements - Slide 3
The balance sheet

The income statement
The statement of cash flows
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Transcript
We will cover 3 basic forms of financial statements. The first one is

the balance sheet. We'll talk about what the balance sheet captures,
how it is organized, and what the items stand for. After that we
introduce income statement. We'll cover how to use income
statement to evaluate the profit or losses of a company. We'll also
explore the link and differences between these two financial
statements. We'll also learn what is the difference between cash
flows and accounting earnings. What are different perspectives of
financiers and accountants and how to derive cash flows? We also
want to talk about the relationship among the three types of financial
statements. After this module you should be able to read financial
statements of a company and interpret the numbers. There's one
more thing I want you to keep in mind before we start to learn
financial statements. Let's go back to the transcript
example.Although the transcript is a quick way to learn the academic
performance of the student, it is impossible to capture everything
about a student. There are a lot of important things that a transcript
cannot tell us.
Beyond the Transcript - Slide 4
Academic Interests
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Transcript
For example, what are the academic interests of the student? And
how creative the student is. When you use financial statements to
evaluate the financial performance of the company, you also need to
bear in mind that you should not be restricted by financial
statements. You need to see the whole picture of the business.
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Financials
Financials
What are financials? (1 of 3) - Slide 5
Publicly traded companies are required to report their financial

reports (financials) to their shareholders and the general public
Transcript
The first question I want to introduce is the concept of financials.

What are financials? According to the requirement of the Security
and Exchange Commission, as you see, publicly traded companies
in the United States should file financial reports to remain listed on
the Stock Exchange. These reports are called financial statements or
financials for short. In the United States, the rules and procedures
used to prepare financial reports are called Generally Accepted
Accounting Principles (GAAP).
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In the United States, the accounting rules that are used to prepare
financial reports are called Generally Accepted Accounting Principles
(GAAP).
Transcript
No instruction is provided for this slide.
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Most other countries use International Financial Reporting Standards
(IFRS).
Transcript
In other countries of the world, like the European Union and more
than 140 countries, they use a different set of rules which are called
International Financial Reporting Standards.(IFRS). There are some
differences between these two sets of accounting standards, but the
people are working to make these two standards more consistent
with each other. Since 2007, the SEC allows foreign companies to
prepare their financials using IFRS.
Financial Information - Slide 8
Company website
Transcript
Another question you may have is where can I get the information on
financials? There are two places - one is through the company's
website. Most large public companies publish their financial reports
on their websites. You just need to visit the company's home page
and click a tab called investors or investor relations.
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Target Investment Example (1 of 8) - Slide 9
This slide shows the investors portion of Target's website where their
stock quote and financial news is listed.
Transcript
You should be able to find all the financial reports there. Here's an
example from Target Corporation, so this is the Target website for
investors, and if you want to check the findings then you can click
the tab investors and when you click the tab, you can see a bunch of
menus over here like what is the corporate overview, stock
information, annual reports and corporate governance.
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This slide shows a list of links to Target's investor tabs such as

annual reports.
Transcript
And here, if you want to check the annual report you can just click
the annual reports.
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This slide shows the top of an article of Target's 2019 annual report
on their website.
Transcript
And then you will see this is the most recent corporation annual
report. And if you scroll down a little bit, you will see the historical
information.
This slide shows an image of Target's website's annual report

archive, where annual reports are listed for download from the
webiste.
Transcript
Let's use one year as an example. So let's click the 2017 annual
report.
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This slide shows the first page of an annual report showing only the
Target logo.
Transcript
The first page of the report is the logo of the company, and when you
Scroll down a little bit you will see some financial highlights like the
sales numbers, the EBIT numbers, net earnings, and diluted
earnings per share.
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This slide shows an infographic of Target's financial highlights
including: sales and net earnings.
Transcript
We will talk about these concepts in the later chapters. When you
scroll down a little bit more, then you can see the total sales - 23%
comes from beauty and household essentials, and 20% comes from
food and beverage. So on and so forth and then followed by a letter
by the CEO and chairman. And after that is the financial summary of
the company.
This slide shows the start of the Financial Summary and the 10-K
form for Target.
Transcript
If you scroll down a little bit more, then you will see the 10K form.
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This slide shows the top of an official form 10-K of Target

Corporation.
Transcript
So this is the financial report, and if you are interested in the financial
report you can also click the download button to download it to your
local computer so that you can use it in the future. Another place you
can get the financials is the SEC's website.
Financials Information (1 of 4) - Slide 17
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Company website
SEC website
Transcript
Financial filings can be searched at the EDGAR website on the

SEC's website.
Financial filings can be searched at the Electronic Data Gathering,

Analysis, and Retrieval system (EDGAR) database on the SEC's
website.
Transcript
No instruction provided for this slide.
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The EDGAR (the Electronic Data Gathering, Analysis, and Retrieval

system) performs automated collection, validation, indexing,
acceptance, and forwarding of submissions by entities who are
required to file forms with the SEC
Transcript
EDGAR stands for the Electronic Data Gathering, Analysis, and

Retrieval system. Companies file the forms required by the SEC
using this system. This database is used widely by academia and
industry researchers.
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EDGAR information
Transcript
Now I want to show you how to use the system to search for files
you need.
EDGAR Navigation (1 of 7) - Slide 21
This slide shows the SEC's website with the mouse with the mouse
focused on a link for company filings.
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Transcript
So if you go to the SEC's website and in the home page you will find
to the upper right corner, you can click a tab which is called company
filings. If you click that then you will be directed to this web page. So
this is the EDGAR company filings web page.
This slide shows the SEC website: company filings tab, with a
search box to search the database for companies.
Transcript
So you can search the information on the company using a

company's name and then click search. There is another way to do it
much faster, which is to use the fast search tab. So here you can
enter the ticker symbol of the company and then search the
company on here. Suppose I'm interested in Target Corporation, I
would enter the ticker symbol TGT over here and then click search.
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This slide shows the results of a search in the EDGAR database, a

list of different filings and different forms from Target.
Transcript
And you will get a web page look like this. So these are all findings
by Target Corporation and you can see a number of findings. South
eight form 8K form is the current report, so they have the findings.
Name the format that description the finding date and also the file
number. And suppose I'm interested in a 10 Q quarterly report.
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This slide shows a Target quarterly report that was clicked on from
the EDGAR database that lists all documents available for viewing
from this particular report.
Transcript
I can click documents, and then check the detailed information. So

this is a quarterly report.
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This slide shows the beginning of a 10-Q form from Target.
Transcript
So this is the 10 Q form and you can scroll down to see the
information of the 10 Q form.
This slide shows the same Target 10-Q report from slide 25 but in a
different document location showing a portion of financial
statements.
Transcript
And if you want to download it to your computer, you can click

control P and print it to a local computer and save it as a PDF file.
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This slide shows the search of the filings with a filter open to filter
results of the filings searched.
Transcript
Let's go back to the search filings, and suppose you are interested in
some specific information or specific date. You can also filter your
result. For example, I'm only interested in the 10K form, so I can just
put 10K over here and then search it. And now you can see all the
filings are 10K filings over here and now you have accumulated all
the 10K forms filed by Target during past years.
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Form 10-K: Annual Report - Slide 28
It captures information such as business description, risk factors,

properties, corporate governance, executive compensation, and
audited financial statements.
Transcript
A form 10K is an annual report required by the SEC. It captures a

comprehensive summary of a company's financial position. The 10K
form includes a detailed description of its major businesses,
competition, risk factors and properties. It also has information about
corporate governance, executive compensation, and most
importantly, the audited financial statements. This form is signed by
its directors to make sure the information delivered here captures the
accurate and complete information about the company.
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Form 10-Q: Quarterly Report - Slide 29
Transcript
In addition to the 10K form, a company is also required to file

quarterly reports on Form 10 Q. Form 10 Q reports the company's
financial situation after each quarter. It is much shorter than the
annual report, and it is unaudited financial statements.
Form 8-K (Current Report) - Slide 30
Discloses unscheduled material events or corporate changes

File the 8-K report within four business days.
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Transcript
The form 8K, also called the current report, must be filed if there are
any major changes to a business or significant events that were not
covered in the 10K or 10 Q reports. What is considered as a
significant event or material event? Some examples, such as the
sudden departure of the CEO , acquisition, bankruptcy or changes in
corporate governance. The public company generally must file a
current report on form 8K within four business days to provide an
update to previously filed quarterly reports and annual reports.
These reports are often important to their shareholders because they
contain information that will affect the share price.
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Balance Sheet
Balance Sheet: Introduction

The Balance Sheet (1 of 7) - Slide 31
Transcript
Now we want to learn the basics of the balance sheet.
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This slide shows an image of Target Corporation's Balance sheet

from 2019 to 2020.
Transcript
Here is an example of a balance sheet of Target Corporation. You

can get it from the company's annual report. This is a condensed
version of the actual balance sheet because I want to use this
version to illustrate some concepts that apply to all the corporations.
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This slide shows the same image as slide 32: an image of Target
Corporation's Balance sheet from 2019 to 2020.
Transcript
The balance sheet takes a snapshot of a firms accounting value at a

certain time. The balance sheet of Target summarizes the value of
the firm as of February 1st, 2020 and February 2nd, 2019. All the
values are in millions.
This slide shows a zoomed image of the same image as slide 32: an
image of Target Corporation's Balance sheet from 2019 to 2020,
showing Current Assets and Fixed Assets.
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Transcript
Let's take a look at the left hand side of the balance sheet. The
assets of the company are listed on the left. The assets can be
divided into current assets and fixed assets. Current assets are the
assets that can be converted into cash within a year. Fixed assets
have a life longer than one year. The current assets include three
major components. First, cash and equivalents refer to cash or
assets that can be converted into cash immediately. Cash
equivalents include bank accounts, money market funds, commercial
paper and Treasury bills. It is followed by accounts receivable. We
can also call it receivables for short. It is the amount of money owed
to a company by its customers who purchased goods or services on
credit. Inventory includes raw materials, work in progress and
finished products. Other current assets include prepaid expenses.
For example, a company purchased the insurance that will cover the
next 12 months. It paid $500,000 up front for the insurance policy.
This amount belongs to a prepaid expenses and the company will
book $500,000 as other current assets.
showing Current Assets and Fixed Assets.
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Transcript
If we sum up these items, we get the total current assets. 12.9 billion
dollars in 2020 and 12.5 billion dollars in 2019. Fixed assets are
composed of tangible assets and intangible assets. Property, plant,
and equipment are tangible assets because they have physical
forms. The net property plant and equipment is the amount after
deducting depreciation. Intangible assets have no physical form.
Some examples include trademarks, patterns and copyrights. The
sum of tangible assets and intangible assets is equal to total fixed
assets. Total fixed assets increased from 28.77 billion dollars in 2019
to 29.88 billion dollars in 2020. Total assets are calculated as the
sum of current assets and fixed assets. Total assets are 42.78 million
in 2020 and 41.29 billion dollars in 2019. The assets are listed in
descending order of liquidity. Most liquid assets are listed on top and
least liquid assets at the bottom. Let's take a look at the right hand
side of the balance sheet.
showing Current Liabilities and Shareholder Equity.
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Transcript
It shows the company's liabilities and equity. From the right hand
side you can tell how the company's assets are financed. The
liabilities are the companies dEBT and other financial obligations. It
is composed of two parts - current liabilities and long-term liabilities.
Current liabilities are the liabilities you have to fulfill within a year. A
company buys goods or services from its suppliers, but has not paid
yet. This amount will be booked as accounts payable. Current
liabilities also include accrued expenses, employee wages not paid
or interest not paid. Long-term liabilities are liabilities that are due
more than one year from the date of the balance sheet. It includes
long-term loans, deferred tax liabilities, and pension liabilities. The
increase from 14.98 billion dollars in 2018 to 16.46 billion dollars in
2020. Let's take a look at the equities part. When a company issues
common stocks and receives more than the par value of the stocks,
the par value part is booked as common stocks and the surplus part
is booked as paid-in capital. The retained earnings, the accumulated
earnings that is retained by the company at the end of the fiscal year,
when we sum up the above items together, we get total stockholders
equity. 11.83 billion dollars in 2020 and around 11.3 billion dollars in
2019. This is also called the book value of the equity. It is quite
different from the equity value traded in the stock market. Total
liabilities and equities are the sum of the current liabilities, long-term
liabilities and stockholders equity.
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This slide shows the same image as slide 32: an image of Target
Corporation's Balance sheet from 2019 to 2020.
Transcript
When you compare the left hand side with the right hand side of the
balance sheet, you will find that the value of the total assets is equal
to the value of total liabilities and shareholders equity.
Balance Sheet Identity - Slide 38
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Assets = Liabilities + Stockholders' Equity
Transcript
This is not just coincidence. This should always be the case. We

also have a name for it. The balance sheet identity. This is also why
we call it a balance sheet.
Balance Sheet: Fiscal Year

Balance Sheet and Fiscal Year - Slide 39
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Transcript
Let's think about when the balance sheet is prepared. In order to

help you understand the question. You can think about yourself.
Suppose you are walking and a photographer takes a picture of you.
At that moment, you are momentarily still in that picture. The same
logic applies to the company. The company is running all the time,
and the balance sheet is a snapshot taken at the end of its fiscal
year. Here comes the question. What a fiscal year is? And how a
company determines its fiscal year? A fiscal year is also called the
financial year or budget year.
Fiscal Year (1 of 5) - Slide 40
A fiscal year is a one-year period used for calculating annual

financial statements in businesses and other organizations.
Transcript
It is a one year period used for calculating annual financial

statements in businesses and other organizations. It is important
because it defines an organization's budget and it is used for
financial reporting.
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Fiscal year of the US Federal government runs from October 1 of the

previous year to September 30 of the current year
Transcript
The fiscal year of US Federal government starts from October 1st of

the budget's prior year to September 30th of the current year.
Suppose the federal government spends 10 billion dollars on
transportation and water infrastructure in November 2019. This
amount would belong to fiscal year 2020. The fiscal year for 46 out
of 50 states run from July 1st to June 30th.
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Most state governments (46 states) fiscal year runs from July 1 of
current year to Jun 30 of the following year
Transcript
Because a lot of public universities rely on funding from the state,

they also set their fiscal year to be consistent with the state's
physical year. For small businesses, such as sole proprietorships
and partnerships, the IRS requires that their fiscal year be the same
as the calendar year.
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Sole proprietorships and partnerships run from January 1 to

December 31 of the same calendar year
Transcript
The main reasoning is that they report all business income as

personal income and the calendar year is used for individual income
tax return. For a big corporation, it has the freedom to choose any
consistent fiscal year when it first forms.
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Corporations have freedom to choose any consistent fiscal year
when first formed
65% of big corporations use January 1 to December 31
Transcript
For about 65% of the public traded companies in the United States.
The fiscal year is the same as the calendar year. If they want to
change the fiscal year later, they have to get the approval from the
IRS and file An 8-K report with the SEC.
Corporate Fiscal Year - Slide 45
Doing business with the federal government

Pick September 30 as the end of fiscal year
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Transcript
A related question is how to determine the fiscal year for a

corporation. If a company is doing a lot of business with the federal
government, a good choice is to match the fiscal year with the
government. If a business has a strong seasonal component like
retail business, a large percentage of their annual profits are
generated in one or two seasons of the year. A smart choice is to
end the fiscal year shortly after the highest revenue time of the year.
That is why most top retailers end their fiscal years after the
Christmas shopping season.
Fiscal Year Examples (1 of 3) - Slide 46
Target
Transcript
For big companies, the ends of their fiscal years are different from
each other. Let's take a look at some examples of public companies.
When you check their annual 10K reports, the end of their fiscal year
is listed on the first page of the report.
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This slide shows an official form 10-K showing that the end of
Target's fiscal year is February 1st, 2020.
Transcript
Target Corporation's fiscal year ends on February 1st, 2020.

According to its rule, Target begins its fiscal year in the first full week
of February and ends its fiscal year on the Saturday nearest January
31st.
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This slide shows an official form 10-K showing that the end of
Walmart's fiscal year is January 31st, 2020.
Transcript
Walmart ends its fiscal year at the end of January. Here is the 10-K
form for Walmart. In 2020, it ends on January 31st. The next fiscal
year begins from February 1st. Walmarts fiscal year is consistent
with other large retailers, because by that time they have already
sold out their holiday inventories, collected their receivables and
realized their profits, this is a perfect time to report their financials to
their shareholders.
Balance Sheet: Other Topics

Balance Sheet Liquidity - Slide 49
Transcript
In this part of the lesson, we want to talk about the several questions
we need to pay attention to when we study the balance sheet.
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Liquidity (1 of 3) - Slide 50
Liquidity: the ease with which an asset can be converted into cash
without significant reduction in its value
Transcript
The first one is liquidity. Liquidity evaluates how easily assets can be
converted into cash without significant reduction in value. When we
compare current assets with fixed assets, current assets are much
more liquid than fixed assets because they can be converted into
cash within one year or less.
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Current assets: high liquidity
Transcript
Within current assets, cash and cash equivalents are the most liquid
because they're already cash. The liquidity of accounts receivable is
higher than inventory. Holding receivables are much closer to cash
than holding inventory, because sales have already been made. The
company just needs to collect the bills from their customers. If a
company wants to get immediate cash, it can sell the receivables to
a factoring company. About 75% of the receivables value will be paid
immediately and the remaining part is rebated once the factor
collects payments from clients.
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Fixed assets: low liquidity
Transcript
Fixed assets are much harder to convert into cash. Some examples
of fixed assets include real estate, vehicles, equipment, assembly
lines and patents. A lot of them are highly specific assets and cannot
be used elsewhere, so their resale values are low. Suppose the
company expects to pay its utility bill, pay its suppliers or employees
in the near future. The easiest way to meet that obligation is to use
cash. They need to prepare enough liquid assets in their hands, at
least enough to fulfill their near term obligations. Liquidity is also
important in case of emergency and unexpected expenses.
Otherwise they have to sell their real estate or equipment to pay their
bills. This is not an efficient way to run a business. We talked a lot
about the importance of liquidity for a company. One question I want
you to think about is -
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Question - Slide 53
Should a company hold a lot of liquid assets?
Transcript
Should the company hold a lot of liquid assets? The answer is that a
company needs to hold an appropriate level of liquid assets. But too
much liquid assets can be bad for business. In order to understand
the question a little bit better, we need to weigh the benefits and
costs of holding liquid assets.
Benefits of liquid assets - Slide 54
50
Fulfill short-term obligations
Transcript
The benefit of holding liquid assets is that the more liquid a firm's
assets, the less likely the firm is to experience problems meeting
short term obligations. Even if in an economic downturn a company
with a lot of liquid assets would be able to pay its creditors easily
without liquidating its fixed assets. The company won't be sued by its
creditors or suppliers for unpaid bills. However, holding liquid assets
has its downsides.
Cost of liquid assets - Slide 55
Lower rate of return
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Transcript
The rate of return from liquid assets is much lower than fixed assets.
Fixed assets define the nature of the business. A business is
valuable because it produces goods and services with the
investments in fixed assets. By investing in liquid assets, the firm
sacrificed opportunity to invest in more profitable investment
vehicles. The most important lesson here is to achieve a balance
between current assets and fixed assets. A company needs to
prepare enough liquid assets to run day-to-day operations smoothly
without sacrificing its ability to generate revenues in the long run.
Here, I want you to think about one question. What's the implication
of liquidity in your personal financial management? This liquidity
topic will also shed light on how you manage your personal finance.
You should have some liquid savings in your bank account to pay
monthly bills and handle unexpected expenses. How much liquid
savings to have is appropriate? One advice to you is to keep about
three to six months of monthly expenses. However, sitting on too
much cash is a terrible choice because the average bank checking
account is paying almost nothing. The return of cash does not keep
up with the retail inflation. Although you won't have any trouble
paying your bills, your purchasing power is reduced. With enough
cash to pay your bills. You should also invest part of your money in
fixed assets such as a house or apartment, furniture, appliances, a
car and your education or entertainment. These assets are not very
liquid. But they make you happy. Increase your productivity and
boost your human capital. Now we want to introduce another
concept. Net working capital.
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Net Working Capital (1 of 2) - Slide 56
Net working capital (NWC) = Current assets − Current liabilities
Transcript
Net working capital is the difference between current assets and

current liabilities. It evaluates whether a company's short term assets
are available to pay short term obligations or not. It is a good
indicator of a firms liquidity in the short term.
Net Working Capital (2 of 2) - Slide 57
53
Positive Net Working Capital: NWC > 0
Negative Net Working Capital: NWC < 0
Transcript
For example, a positive net working capital indicates that a company

has enough short-term liquidity to pay its current obligations. A
negative net working capital means that a company needs to borrow
money from a bank or raise money from investors to remain solvent.
When we study the balance sheet, we also need to understand
difference between book value and market value. The balance sheet
shows you the book value of assets.
Book value of assets - Slide 58
Assets shown on the balance sheet at their original cost adjusted for
depreciation and amortization
Transcript
It is calculated as the historical value of the asset less accumulated

depreciation and amortization.
54
Market value of assets - Slide 59
The current price at which buyers and sellers would trade their
assets in the marketplace
Transcript
Market value refers to the current asset price in the marketplace.

The book value of an asset may be quite different from its market
value. For example, a company bought a copy machine for $5000
and booked $1000 as depreciation in the first year. The remaining
book value of the copy machine is $4000. The same machine is
currently trading in the market at $4500. In this case, the market
value of the asset is higher than the book value of the asset.
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Book value of Equity - Slide 60
The difference between a company's total assets and total

liabilities
A plug-in number to ensure that the balance sheet is balanced
Transcript
The book value of equity is calculated by subtracting all liabilities

from total assets. This relationship comes from the balance sheet
identity. Because of the current accounting rules and difficulties in
valuing assets and liabilities, the book value of shareholders equity
serves as a plug-in number to make sure the balance sheet is
balanced. The market value is the value of a company based on the
financial markets.
56
Market value of Equity - Slide 61
Current stock price multiplied by the number of outstanding

shares
Also called market cap
Transcript
The market value of equity is calculated by multiplying the current

share price by the total number of shares outstanding. Market value
of equity is also called market capitalization. Let's compare the book
value and market value of equity for Target. According to the balance
sheet, the book value of shareholders equity is 11.8 billion dollars.
The market value is derived using the total number of shares
outstanding. 510.9 million shares times the current market price.
57
Target Stock - Slide 62
This slide shows a line graph from Yahoo Finance depicting the price
of Target shares between June 2019 and May 2020.
Transcript
The graph shows you Target's share price information for the past
year. The stocks price is fluctuating between the range of $80.00 per
share and $120.00 per share. The market cap is in the range of $40
billion dollars to 60 billion dollars, which is much higher than the
book value 11.8 billion dollars. Target's market value is greater than
its book value, which means investors trust the earnings capability of
Target and believe the company is worth more than its book value.
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Income Statement
Income Statement
Profitable Companies - Slide 63
Transcript
When you are interested in a company, you might be curious about

how profitable the company is. In order to answer that question, you
need to learn another important financial statement - the income
statement.
59
The Income Statement - Slide 64
Revenue − Expenses = Income
Transcript
The income statement shows the company's revenues, expenses,

and income over an entire fiscal year. The accounting income is
calculated based on the identity here. You can think of income
statement as videotaping all the economic activities carried out by a
company within the fiscal year.
Target Income Statement - Slide 65
60
This slide shows an image of an income statement for Target
Corporation during 2019 to 2020. It shows expenses and income in
various forms and how this affects net income.
61
Transcript
The table here shows you the income statement of Target

Corporation for fiscal year 2019. The first line shows the company's
total revenue from February 3rd, 2019 to February 1st, 2020 is 78.1
billion dollars. The cost of sales, 54.9 billion dollars, are the direct
expenses to produce all the goods and services. It includes
production costs, storage costs, and direct labor costs. When you
subtract the cost of sales from total revenue, you get gross profit of
23.2 billion dollars. Gross profit reflects a company's efficiency in
producing goods or services. Selling, general and administrative is
16.2 billion dollars, which is also called as SG&A. It includes indirect
costs or fixed costs of running a business. Some examples are
advertising, insurance, utilities, rent and management salaries.
Almost all the other costs not directly related to production can be
grouped into SG&A. Depreciation and amortization are 2.3 billion
dollars. These are the expenses of the fixed assets spreading out its
useful life. If the fixed asset is a tangible asset, we call the expense
depreciation. We call it amortization if the fixed asset is an intangible
asset. Operating income is 4.66 billion dollars, which is calculated by
subtracting SG&A and depreciation and amortization from gross
profit. For Target Corporation, operating income is the same as
earnings before interest and taxes, also called EBIT. Because there's
no other income, EBIT is a very important indicator to value the
performance of a companies core business without considering the
capital structure and tax expenses. EBIT is also a widely used input
variable for a lot of financial ratios. Interest expense is 468 million
dollars, which is the cost of borrowing money from creditors. This
expense does not depend on operations, but on a companies capital
structure. Interest expense is tax deductible. When you deduct the
interest from EBIT, you derive earnings before income tax, which is
also called EBT or pretax income. Based on EBT and tax rate, you
can calculate how much tax you need to pay to the government.
Target paid 909 million dollars to the government during the year.
When income tax is deducted, you get the net income, 3.28 billion
dollars. This net income is also called net earnings or the bottom
line. This is the total amount a company earned after deducting all
62
expenses, interest and taxes from revenue. It is an indicator of how
profitable a company is. Using net income and dividing it by total
outstanding shares of common stock, 510.9 million shares, you can
derive the earnings per share EPS. Target earnings per share is 6.42
dollars per share. Part of the earnings is distributed to shareholders
as dividends and the remaining part will be retained by the company.
Target distributes $2.62 per share to shareholders. Dividing cash
dividend, $2.62, by earnings per share, $6.42, yields a dividend
payout ratio of 41%. It means the company pays out 41% of its
earnings as dividends. The remaining part, 59%, is called retention
ratio or plowback ratio. The company retains 59% of its earnings to
support its future growth. For a company with a high growth
potential, a smart choice is to plowback the earnings and the
reinvest them in the company's operations. This is why you observe
a retention ratio of 100% for a lot of fast growing companies.
63
Cash Flow of the Firm
Statement of Cash Flow

Cash Flow - Slide 66
Transcript
Let's take a look at the cash flow statement. Here you may wonder,
since we already have the balance sheet and income statement.
Why do we need an additional statement? The balance sheet is a
summary of a company's assets, liabilities, and owners equity at a
certain time. The income statement shows the company's revenues
and expenses during a period of time.
64
The Statement of Cash Flows - Slide 67
It provides information about the change in cash flows.
Transcript
The cash flow statement fills the gap between the balance sheet and
income statement by showing how much cash is generated or spent
operating, investing and financing activities for a specific period of
time. I would like to explain about different perspectives of a financier
and accountant. A financier cares more about the cash inflows and
cash outflows of a company, because cashflows determine the value
of a business.
65
Financiers vs. Accountants - Slide 68
Financiers: cash inflows and outflows

Accountants: net income
Difference: noncash items such as depreciation and
amortization
Transcript
Accounts pay more attention to accounting net income. The cash

flow is different from earnings because of the non-cash items such
as depreciation and amortization. We can set up an example to help
you understand the problem. Suppose a company buys a copy
machine for $5000, and the life of the machine is 5 years.
66
Cashflow Example - Slide 69
Financier vs Accountant Cash Outflow

Financiers: Cash Accountants Depreciation
Year
Outflow Expense
1 $5,000 $1,000
2 0 $1,000
3 0 $1,000
4 0 $1,000
5 0 $1,000
Transcript
The financier sees a cash outflow at the very beginning and no cash
flows in the following years. For accountants, they spread out the
cost of $5000 evenly in the five years. The depreciation expense in
each year is $1000 according to the straight line depreciation
method. Here we want to explain why cash flow analysis is so
popular in finance.
67
GAAP Accounting Principles - Slide 70
Allows for significant subjective decisions to be made
Transcript
Based on GAAP accounting principles, accountants can also use a

different depreciation schedule to spread out the expenses of assets.
There are a lot of leeway in such decisions. Depreciation has an
impact on how much taxes a company pays to the government and
affect net income. Besides depreciation, there other items in the
balance sheet and income statement that also suffer from the same
problem.
68
Cash Flow Analysis - Slide 71
Difficulty in manipulating and spinning the numbers
Transcript
Cash flow is a more accurate way to capture the company's financial

health because the cash flow numbers are hard to manipulate. The
statement of cash flows is composed of three categories - operating
activities, investment activities and financing activities.
Statement Example (1 of 3) - Slide 72
69
This slide shows a cash flow statement of the Target Corporation
showing the adjustments made to reconcile non cash items to the
net income.
Transcript
The operating activities part start with net income, 3.28 billion
dollars, which is the bottom line of the income statement. Then we
need to adjust for all the non cash items accordingly. First, we add
back depreciation and amortization which is 2.6 billion dollars.
Because depreciation expense is not a cash outflow, when we
calculate the net income, we deduct it as an expense and now we
need to add it back. We also add other non cash items such as
share based compensation expense, 147 million dollars, and 178
million dollars of deferred income taxes. In addition to that, we need
to adjust for cash flows generated by operating assets and liabilities.
For example, Target's inventory decreased 505 million dollars during
the year. This decrease in inventory is considered a cash inflow of
Target because cash is freed up from inventory and available to be
used elsewhere. Change in other assets brings a cash inflow of $18
million. There is 140 million cash inflow from change in accounts
payable and 199 million dollars cash inflow from change in accrued
and other liabilities. This reflects a net increase in charged expenses
which have not been paid by Target. Overall, Target generated 7.12
billion dollars of cash flow from operating activities for the period
ending February 1st, 2020.
70

showing the cash required for all investing activites during this
statement period.
Transcript
In fiscal year 2019, Target spent 3.03 billion dollars in capital

expenditure. This amount of money is used to invest in new property,
plant and equipment. According to the annual report of Target. About
the 64.5% of the capital expenditure was invested to remodel
existing stores. 8.7% was used to build new stores and the
remaining 26.8% was spent on information, technology, supply chain
and others. This expenditure won't be shown in the income
statement because it will be spread out over the life of the asset as
depreciation. Target collected $63 million from selling property, plant
and equipment and earned $20 million from other investments. The
total cash required for all investing activities is 2.94 billion dollars.
This represents a cash outflow for the company.
71

showing the cash changes from all financing activites during this
statement period.
72
Transcript
The last part of the statement of cash flows is the cash flows from
financing activities. Target raised 1.74 billion dollars by issuing long-
term dEBT, paid back 2.7 billion dollars of previously issued long-
term dEBT to its creditors. It paid out 1.33 billion dollars as
dividends, its shareholders and the repurchased 1.57 billion dollars
from existing shareholders. The company also received $73 million
in cash from stock option exercise. Therefore, the total cash required
for financing activities is 3.15 billion dollars. This reflects the cash
flow to Targets creditors and shareholders. Now we put these three
parts together and calculate the net change in cash and cash
equivalents. Target has total cash inflows of 1.02 billion dollars in
fiscal year 2019. We also want to link this information with the
balance sheet. At the beginning of fiscal year 2019, that is February
2nd, 2019, cash and cash equivalents stood at 1.56 billion dollars.
With cash inflows added during the year. The new cash and cash
equivalence is 2.58 billion dollars. This perfectly matches the
numbers in the balance sheet. When we combine the information
from the statement of cash flows with the balance sheet and the
income statement, we have a better understanding of the company's
financial situation.
73
Module 2 Wrap Up
Module 2 Wrap Up
Financials - Slide 75
10-K
10-Q
8-K
Transcript
In this module, we introduce the financials. There are some widely

circulated in the reports, including 10-K annual report, 10-Q quarterly
report, and the 8-K current report.
74
Access to Financials - Slide 76
Company's website
SEC website
Transcript
Financial reports can be easily accessed through companies

websites or SEC EDGAR website.
Financial Statements - Slide 77
The balance sheet
75
The income statement
The statement of cash flows
Transcript
We learn of three times of financial statements. The balance sheet,

the income statement, and the statement of cash flows.
Balance Sheet - Slide 78
Assets ≡ Liabilities + Stockholders' Equity

Fiscal year
Transcript
The balance sheet shows the company's assets, liabilities, and

shareholder's equity. The balance sheet is organized according to
the balance sheet identity. The assets of a company are listed on the
left side, and the liabilities and shareholders equity are listed on the
right-hand side. We covered the basics of a fiscal year, the definition
of a fiscal year, and how to determine a fiscal year for our business.
76
Assets - Slide 79
Liquidity
Net working capital
Book value vs. market value
Transcript
Assets are listed based on their liquidity. Well, liabilities are listed
according to their due days. We learn a how to calculate the net
working capital based on the balance sheet. We also talked about
the difference between book value and market value. All the values
in the balance sheet are book values. They might be quite different
from their market values.
77
Income Statement - Slide 80
Revenue − Expenses ≡ Income

EBIT
Transcript
We also learned the income statement. We start with total revenue

and deduct the cost and other expenses until we reach the bottom
line. Some important concepts I introduced. Earnings before interest
and taxes is a very important indicator to value the performance of a
company's core business without considering the capital structure
and the tax expenses.
78
Net Income - Slide 81
Transcript
Net income is the bottom line. It is the total amount a company

earned after deducting all expenses, interest, and taxes from
revenues. It can be used to evaluate whether a company make a
profit or not.
Earnings per Share - Slide 82
79
Transcript
Earnings per share is the earnings based on each outstanding

share. Earnings will either be distributed to shareholders or retained
in the company to finance it's future investments.
Statement of Cash Flows - Slide 83
Cash flow from operating activities

Cash flow from investing activities
Cash flow from financing activities
Transcript
Last, we talked about the statement of cashflows. It shows a

company's inflows and outflows of cash. A cashflow statement can
tell us whether the company generated cash flow or not. Cashflow
statements are grouped into three parts. Each part reports the
cashflow from one of three kinds of activities, operating activities,
investing activities, and financing activities. We talked a lot about
financial statement, but I have one caveat to share with you.
80
Caveat - Slide 84
Look beyond a company's financial statements
Transcript
In this module, let's get introduced to the basics of Finance. In order

to learn finance, we first need to know some basics about the
structure and raw or firms at the center of Finance because they
create the wealth in society. Think about your daily life. In the
morning you may go to your favorite local cafe or Starbucks to get a
Cup of coffee for breakfast. The local cafe is a small business and
Starbucks is the world's largest coffeehouse chain. They have
something in common and they also have a lot of differences.
81
Table of Contents
1. Introduction to Finance: The Basics Module 2
1. Module 2 Overview
1. Module 2 Overview
2. Financials
1. Financials
3. Balance Sheet
1. Balance Sheet: Introduction
2. Balance Sheet: Fiscal Year
3. Balance Sheet: Other Topics
4. Income Statement
1. Income Statement
5. Cash Flow of the Firm
1. Statement of Cash Flow
6. Module 2 Wrap Up
1. Module 2 Wrap Up
82

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This Gies eBook is based on an extended video lecture transcript

Each Gies eBook is broken down by lessons that are navigable

Within the lesson, every time there is a slide change or a switch to

Thumbnail image of the current slide or video scene

Note: Links will open in a new window in your browser, unless

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Published by the Gies College of Business at the University of Illinois

In this module will learn the basics of financial statements. In order to

The balance sheet

We will cover 3 basic forms of financial statements. The first one is

Beyond the Transcript - Slide 4

What are financials? (1 of 3) - Slide 5

Publicly traded companies are required to report their financial

The first question I want to introduce is the concept of financials.

No instruction is provided for this slide.

What are financials? (3 of 3) - Slide 7

Financial Information - Slide 8

This slide shows a list of links to Target's investor tabs such as

Target Investment Example (3 of 8) - Slide 11

Target Investment Example (4 of 8) - Slide 12

This slide shows an image of Target's website's annual report

Target Investment Example (6 of 8) - Slide 14

Target Investment Example (7 of 8) - Slide 15

This slide shows the top of an official form 10-K of Target

Financials Information (1 of 4) - Slide 17

Financial filings can be searched at the EDGAR website on the

Financials Information (2 of 4) - Slide 18

Financial filings can be searched at the Electronic Data Gathering,

No instruction provided for this slide.

The EDGAR (the Electronic Data Gathering, Analysis, and Retrieval

EDGAR stands for the Electronic Data Gathering, Analysis, and

EDGAR Navigation (1 of 7) - Slide 21

EDGAR Navigation (2 of 7) - Slide 22

So you can search the information on the company using a

This slide shows the results of a search in the EDGAR database, a

I can click documents, and then check the detailed information. So

EDGAR Navigation (5 of 7) - Slide 25

EDGAR Navigation (6 of 7) - Slide 26

And if you want to download it to your computer, you can click

It captures information such as business description, risk factors,

A form 10K is an annual report required by the SEC. It captures a

In addition to the 10K form, a company is also required to file

Form 8-K (Current Report) - Slide 30

Discloses unscheduled material events or corporate changes

Balance Sheet: Introduction

The Balance Sheet (1 of 7) - Slide 31

Now we want to learn the basics of the balance sheet.

This slide shows an image of Target Corporation's Balance sheet

Here is an example of a balance sheet of Target Corporation. You

The Balance Sheet (3 of 7) - Slide 33

The balance sheet takes a snapshot of a firms accounting value at a

The Balance Sheet (4 of 7) - Slide 34

The Balance Sheet (5 of 7) - Slide 35

The Balance Sheet (6 of 7) - Slide 36

Balance Sheet Identity - Slide 38

This is not just coincidence. This should always be the case. We

Balance Sheet: Fiscal Year

Balance Sheet and Fiscal Year - Slide 39

Let's think about when the balance sheet is prepared. In order to

Fiscal Year (1 of 5) - Slide 40

A fiscal year is a one-year period used for calculating annual

It is a one year period used for calculating annual financial