Master the four essential tips for financial statement analysis and instantly uncover the true nature of a company

Why Investors Must Understand Financial Statements

Warren Buffett once said something that resonates deeply: “Financial reports are the company’s dialogue with the outside world. Learn to interpret them, and you’ll be able to make independent investment decisions.” This is not alarmist. In the stock market, whether you make money often depends on how well you understand your investment targets—and financial reports are the most direct window into understanding a company.

Many investors buy stocks like lottery tickets, relying entirely on luck. But investors who understand financial statements are different; they can filter out truly valuable companies through data and avoid risks hidden behind impressive performance. This article will guide you to a deeper understanding of financial reports, teach you to speak with data, and help you make smarter investment choices.

What Exactly Are Financial Statements? A Regular Health Checkup Report for Companies

Financial Reporting is the report card that listed companies regularly present to investors. It records core data such as operating revenue, operating costs, profit and loss, assets, and liabilities. Simply put, financial reports are like annual health checkup reports for companies, clearly showing their health status.

Based on the business cycle, financial reports are divided into three categories:

• Annual Reports: Disclose a full year’s operational results, providing the most comprehensive information
• Quarterly Reports: Record quarterly performance progress, capturing key moments
• Monthly Reports: Some companies disclose brief monthly summaries for timely tracking

For example, in the U.S. market, all listed companies must submit annual reports (Form 10-K), and domestic companies are also required to disclose quarterly reports (Form 10-Q). The annual report must be filed with the U.S. Securities and Exchange Commission (SEC) within four months after the fiscal year ends. This mandatory disclosure system protects investors’ right to information.

The Four Major Financial Statements: Understanding the Core Indicators of a Company

If we compare a company to a person, then the four financial statements are:

Balance Sheet: How strong is the company’s foundation?

Balance Sheet is like a company’s asset list. It summarizes with a simple formula: Assets = Liabilities + Shareholders’ Equity

Imagine an entrepreneur invests 5 million NT dollars to open a gym:

• 3 million is self-earned (Shareholders’ Equity)
• 2 million borrowed from the bank (Liabilities)
• The 5 million is used for rent, renovation, equipment, leaving 500,000 NT in cash

This is the core of the balance sheet—recording the sources and uses of money.

Assets are classified by liquidity:

• Current Assets: Cash, accounts receivable, inventories, etc., easily converted to cash in the short term
• Non-current Assets: Factories, equipment, intangible assets, requiring longer time to convert

Liabilities are classified by repayment period:

• Current Liabilities: Debts due within one year, such as accounts payable, wages
• Long-term Liabilities: Debts due after more than one year, such as bonds payable, long-term loans

Shareholders’ Equity is the part that truly belongs to shareholders after deducting all debts.

Practical perspective: TSMC’s Asset Allocation

TSMC’s Q1 2025 balance sheet reveals typical features of a top manufacturing company:

Current Assets: Cash and equivalents amount to NT$23,948 billion, up 41% year-over-year, accounting for 34% of total assets. This indicates TSMC is extremely cash-rich, with strong risk resistance and capacity to reward shareholders. Inventory increased by 9.8% compared to last year, reflecting ongoing production capacity and business activity.

Non-current Assets: Since manufacturing wafers requires advanced and expensive equipment, TSMC’s plant and equipment account for 48% of total assets. In Q1 2025, non-current assets increased by NT$452.5 billion, with plant and equipment rising NT$349 billion, showing active capacity expansion.

Liability Structure: TSMC’s current liabilities almost contain no short-term borrowings, mainly operating liabilities like accounts payable and wages, indicating a healthy company. Long-term liabilities are mainly raised through bonds, with about NT$948.3 billion in bonds payable in Q1 2025.

Quick Ratio and Debt Ratio: Measuring a Company’s Debt Repayment Ability

Quick Ratio = (Current Assets - Inventories) / Current Liabilities

This ratio measures whether a company can quickly pay off short-term debts. A ratio of 1:1 is generally healthy. TSMC’s Q1 2025 quick ratio is 2.18, far above industry standards, indicating very strong short-term debt-paying ability.

Debt Ratio = Total Liabilities / Total Assets

The lower, the better—indicating less reliance on debt. TSMC’s ratio has decreased from 40.37% in 2022 to 35.49% in Q1 2025, showing continuous financial structure optimization and increased risk resistance.

Income Statement: How Much Money Did the Company Make in a Year?

Income Statement is like a profit report, showing the company’s earning ability with this formula:

Net Profit = Operating Revenue - Costs - Expenses - Taxes

The income statement is divided into three layers from top to bottom:

First Layer: Revenue Money earned from selling products or services. TSMC’s revenue comes entirely from wafer sales. In Q1 2025, net revenue was about NT$839.3 billion, a 41.6% YoY increase, an impressive growth rate.

Second Layer: Costs and Expenses

• Costs: Direct expenses for manufacturing, such as raw materials and manufacturing costs
• Expenses: Indirect costs like sales, marketing, R&D

Gross Profit = Operating Revenue - Costs, higher gross profit indicates more valuable products.

TSMC’s gross profit margin in Q1 2025 reached 58.8%, up from 53.1% last year, a rare high margin in manufacturing, reflecting its leading process technology.

Operating expenses in the same period were about NT$85.2 billion, with R&D expenses at NT$56.5 billion, accounting for 6.7% of revenue. As a global leader in wafer manufacturing, TSMC continues to invest heavily in R&D to maintain technological leadership. However, the declining R&D expense ratio warrants attention—rising competition makes this a potential concern.

Third Layer: Net Profit After deducting all costs, expenses, and taxes, the company’s true profit. TSMC’s net profit in Q1 2025 was NT$360.7 billion, up 60.2% YoY, significantly outpacing revenue growth. This is driven by higher gross margins and lower expense ratios.

Profit Margin: Measuring a Company’s True Profitability

Net Profit Margin = Net Profit / Operating Revenue

This is the ultimate indicator of profitability. A high gross margin can be misleading if expenses and taxes are high, resulting in a low net margin. TSMC’s net margin has shown a remarkable upward trend, indicating the company not only sells well but also manages efficiently.

Cash Flow Statement: Is the Company Really Making Money?

Cash Flow Statement is often overlooked but is the most important report. It answers a key question: Are these profits real cash, or just accounting figures?

Cash flows are divided into three types:

Operating Cash Flow: Cash generated or used by daily operations. This is the most critical cash flow—if positive, it indicates the company is genuinely profitable.

Investing Cash Flow: Cash from buying or selling assets. Positive means asset sales; negative indicates expansion investments.

Financing Cash Flow: Cash from borrowing or financing, or used to repay debt and dividends. Negative financing cash flow indicates debt repayment or shareholder dividends.

Interpreting the Eight Business Profiles Based on Cash Flows

Depending on the positive or negative combination of the three cash flows, you can judge the company’s true situation:

TSMC’s cash flow belongs to the third type—normal operations with ongoing expansion, a typical feature of a mature, high-quality company.

Shareholders’ Equity Change Table: Where Did the Shareholders’ Money Go?

Shareholders’ Equity Statement tracks changes in the company’s owners’ equity. A company’s owners’ equity consists of:

Share Capital: The initial capital invested by shareholders, usually unchanged unless new shares are issued or dividends are distributed.

Capital Surplus: The premium from issuing shares above face value. When shares are issued at a premium, the excess goes into capital surplus.

Retained Earnings: Profits retained in the company, including statutory and discretionary reserves.

Undistributed Profits: Profits earned but not distributed to shareholders. The larger this number, the more cash the company has retained.

Other Equity: Asset appreciation unrelated to profits, such as investment gains.

This statement reveals whether the company distributes profits to shareholders or retains them for growth; whether shareholders are increasing their investments or reducing holdings.

Pitfalls in Financial Statement Analysis: Limitations You Must Know

Data Traps

Financial statements record past events and have limited predictive power. Many intangible assets like brand, talent, and technological accumulation cannot be quantified.

More critically, financial reports are not entirely objective. Companies can “beautify” their reports within accounting standards. The Luckin Coffee fraud case is an extreme example—faking NT$20 billion in sales to lure investors, leading to huge losses. It reminds us that even beautiful-looking data must be verified.

Indicator Limitations

Industry differences are significant. Real estate companies inherently have poor liquidity; their current ratios may be far below 2:1. Industries with large cash sales often have little or no accounts receivable. You cannot measure all companies with the same standard.

Short-term data can also create illusions. During promotional periods, inventory may increase and cash flow decrease, but this is only a short-term phenomenon, not a sign of deteriorating quality.

Key Points When Reading Financial Reports for Decision-Making

Besides the four main reports, investors should also pay attention to:

Operational Indicators: Daily active users and views for short-video companies; land acquisition, construction, and completion rates for real estate; number of agents for insurance companies, etc. These data are closely related to the company’s survival.

Future Planning: Forward-looking guidance in financial reports is often more important than historical data. A company’s development plan helps investors anticipate future prospects.

Dividend Policy: Companies with stable cash dividend policies usually have steady profits and ample cash. TSMC shifting from stock dividends to stable quarterly cash dividends reflects mature business and confidence in the future, providing market and investors with strong reassurance.

Ways to Quickly Access Financial Reports

• Company Official Website: Check announcements and official financial reports directly
• Stock Exchange: For Taiwanese listed companies, check the Taiwan Stock Exchange; for U.S. companies, check the SEC website
• Announcement Platforms: Taiwan Stock Exchange’s “Fast and Easy Announcement Search” feature is convenient

Conclusion

Financial statement analysis is a practical skill. You don’t need to be an accountant or become Buffett overnight. Master the basic logic of the four main reports, understand the meaning of key indicators, and combine this with industry characteristics to form a relatively objective view of a company.

True investment experts don’t just read financial reports—they analyze industry trends, competitive landscape, management capabilities, and more. Start reading and understanding financial reports today, and take your first step on the right path of investing.