Beginner's Guide: What Is the Investment Logic Behind Financial Statements?

▶ Why must investors understand financial reports?

Warren Buffett once said, revealing the value of financial reports: “You must understand financial statements; they are the language through which a company communicates with the outside world. Only by willing to spend time learning and analyzing them can you independently choose your investment targets. Your investment returns are proportional to your understanding of the investment object.”

In simple terms, reading financial reports is like giving a company a health check-up. A complete financial report will tell you: how much money the company made, how much it spent, how much debt it owes, and how much cash it holds. These data directly determine whether a company is worth your investment.

On trading platforms like Gate.io, many users, besides trading crypto assets, also allocate some funds to listed company stocks. Learning to read financial reports can help you filter out truly valuable investment targets from thousands of companies.

▶ What exactly are financial reports?

Financial Reporting is a periodic summary document disclosed by listed companies detailing their operational results. It includes core financial indicators such as revenue, operating costs, net profit, asset structure, and debt levels, serving as the only official channel for investors to understand a company’s fundamentals.

After issuing stocks to raise funds, companies are legally obliged to disclose their operational status to investors. This mandatory disclosure system protects investors’ right to information.

According to disclosure cycles, financial reports are divided into three categories:

• Annual Reports: A comprehensive summary of the entire fiscal year, most valuable for reference
• Quarterly Reports: Disclose performance changes quarterly, reflecting company trends in a timely manner
• Monthly Reports: Some industries and regions require monthly financial data disclosure

For example, in the US market, all listed companies must submit Form 10-K (annual report); domestic companies additionally disclose Form 10-Q (quarterly report); non-US companies usually have no mandatory quarterly reporting. Annual reports must be submitted to the SEC within four months after the fiscal year ends.

▶ Master the four core financial statements

Financial reports consist of multiple documents, but the core is the Four Major Financial Statements: Balance Sheet, Income Statement, Cash Flow Statement, and Statement of Shareholders’ Equity. These four are like the “limbs” of a company, providing a complete picture of its operations.

1. Balance Sheet — The company’s “Asset Inventory”

Balance Sheet reflects the structure of assets, the scale of liabilities, and shareholders’ equity, maintaining a balance among them. Simply put, it is a detailed inventory of the company’s “property” and “debts.”

Core accounting equation: Assets = Liabilities + Shareholders’ Equity

Imagine this scenario: You invest 5 million yuan to open a gym. Of this, 3 million is your own capital, and 2 million is a bank loan. The 5 million is used for leasing space, renovations, and equipment, ultimately spending 4.5 million, leaving 0.5 million in cash.

In this example:

• Assets = 5 million (initial investment)
• Liabilities = 2 million (bank loan)
• Shareholders’ Equity = 3 million (own contribution)
• Remaining cash = 0.5 million

The balance sheet records these “sources” and “uses” of money.

Assets are divided into two categories:

Current Assets — Assets that can be converted into cash within a short period

• Cash and cash equivalents (bank deposits, short-term bonds)
• Accounts receivable (money owed by customers)
• Inventory (goods for sale)

Non-current Assets — Assets that are difficult to convert into cash quickly

• Factories, machinery, equipment
• Real estate
• Intangible assets (patents, trademarks)
• Long-term investments

Liabilities are also divided into two categories:

Current Liabilities — Debts payable within one year

• Short-term loans
• Accounts payable (money owed to suppliers)
• Wages payable

Non-current Liabilities — Debts payable after more than one year

• Bonds payable
• Long-term bank loans
• Long-term lease liabilities

Shareholders’ Equity is the company’s “net assets” — if all assets are liquidated and debts paid off, the remaining belongs to shareholders.

Key ratios of the balance sheet:

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

• Measures the company’s ability to pay short-term debts immediately
• Generally, a ratio around 1:1 is considered healthy
• The higher the ratio, the lower the debt repayment pressure

Debt Ratio = Total Liabilities / Total Assets

• Reflects the company’s leverage
• Higher ratios indicate greater financial risk
• Industry standards vary

Taking TSMC’s Q1 2025 data as an example:

• Cash and equivalents: NT$239.48 billion, up 41% YoY, accounting for 34% of total assets
• Total current assets: NT$305.23 billion
• Current liabilities: NT$139.98 billion
• Quick Ratio ≈ (305.23 - inventory) / 139.98 ≈ 2.18
• Debt ratio ≈ 35.49%

TSMC’s high quick ratio and low debt ratio indicate a solid financial structure with strong risk resistance.

( 2. Income Statement — The company’s “Profitability Check”

Income Statement, also called Profit and Loss Statement, directly shows how much profit or loss a company made over a period. It is the most closely watched report by market investors.

Basic formula: Net Profit = Revenue - Costs - Expenses - Taxes

Main components:

Revenue — Cash earned from selling goods or providing services

• TSMC’s Q1 2025 revenue: NT$839.3 billion, up 41.6% YoY

Cost of Goods Sold (COGS) — Direct production costs proportional to revenue

• Lower costs mean higher gross profit margin

Gross Profit = Revenue - COGS

• Reflects the profitability of the company’s products

Operating Expenses — Daily operational costs, divided into three categories:

• Selling and Marketing Expenses: Promotion costs
• R&D Expenses: Investment in new product development
• Administrative Expenses: Management salaries, office rent, etc.

Operating Profit = Gross Profit - Operating Expenses

• Shows core business profitability

Net Profit = Operating Profit - Taxes

• The company’s final profit or loss

Key profitability metrics:

Gross Margin = Gross Profit / Revenue

• The higher, the more value-added and competitive the product
• TSMC’s Q1 2025 gross margin: 58.8%, up from 53.1% in 2024 by 5.7 percentage points
• Indicates continuous manufacturing process advantages

Net Margin = Net Profit / Revenue

• Measures overall profitability efficiency
• TSMC’s Q1 2025 net profit: NT$360.7 billion, up 60.2% YoY
• The net profit growth rate (60.2%) exceeds revenue growth (41.6%), showing effective cost control

Earnings Per Share (EPS) = Net Profit / Total Shares

• TSMC’s Q1 2025 EPS: NT$13.95
• This metric directly influences stock valuation

A noteworthy phenomenon: TSMC’s revenue grew 41.6%, but net profit increased 60.2%. What does this imply? The company expanded sales while reducing costs and improving efficiency, achieving higher profit growth—typical of a healthy, efficient enterprise.

) 3. Cash Flow Statement — The company’s “blood circulation”

Cash Flow Statement tells you: where does the company’s cash come from, and where does it go?

Many companies appear profitable but have tight cash flow, ultimately facing liquidity issues. The cash flow statement is the key tool to identify such risks.

Cash flows are divided into three parts:

Operating Cash Flow — Cash generated from daily operations

• Inflows: Cash from sales, service payments
• Outflows: Raw material purchases, employee wages, taxes
• Most important: Operating cash flow should be positive and continuously growing

Investing Cash Flow — Cash from investment activities

• Inflows: Sale of assets, investments, returns
• Outflows: Purchase of equipment, building factories, investments
• Focus: Is the company expanding or contracting?

Financing Cash Flow — Cash from financing activities

• Inflows: Bank loans, bond issuance, financing
• Outflows: Debt repayment, interest payments, dividends
• Warning signals: Continuous inflow may indicate high debt risk

Eight typical cash flow patterns:

TSMC’s cash flow characteristics:

In 2022:

• Operating cash flow: + NT$161.06 billion (net inflow)
• Investing cash flow: - NT$119.09 billion (net outflow)
• Financing cash flow: - NT$20.02 billion (net outflow)

This aligns with a “stable business + ongoing expansion + shareholder returns” healthy pattern. Operating cash flow is sufficient, with part reinvested in facilities and part returned to shareholders.

( 4. Statement of Shareholders’ Equity — The company’s “capital evolution”

Statement of Stockholders’ Equity tracks how shareholders’ equity changes over an accounting period. It answers: How has the capital invested by shareholders changed due to company operations?

Equity = Assets - Liabilities (also called net assets)

Main components:

Share Capital — Capital contributed by shareholders at issuance

• Share Capital = Par value × Number of shares
• Usually stable; increases only with new issuance, rights issues, or capital increases

Capital Surplus — Excess paid over par value

• For example, shares issued above face value, the excess goes here

Retained Earnings — Profits retained in the company

• Legal Reserve: Legally required to be set aside (usually 10% of after-tax profit)
• Discretionary Reserve: Voluntary retention for risk mitigation

Undistributed Profits — Profits not yet distributed as dividends

• Companies may retain profits for growth, risk buffer, etc.

Other Equity Items — Changes unrelated to profit

• e.g., unrealized gains from holding other stocks

TSMC’s shareholder equity features:

TSMC maintains a stable quarterly cash dividend policy (quarterly dividends), indicating:

• Stable profitability
• Sufficient cash flow
• Management confidence in future prospects

The transition from issuing stock dividends to quarterly cash dividends reflects the company’s move toward maturity.

▶ Limitations you must know before reading financial reports

) Data limitations

Past ≠ Future Financial reports record historical data, reflecting past performance only. They cannot accurately predict future trends.

Unquantifiable value Many important factors are hard to quantify:

• Intangible assets (brand value, customer loyalty)
• Human capital (management quality, employee skills)
• Market risks (policy changes, industry competition)

Incomplete information Companies only disclose mandatory information. Insider information with significant impact may be undisclosed.

Human factors Accounting personnel may “beautify” reports. There have been cases of financial fraud (e.g., Luckin Coffee inflating sales by 20 billion RMB). Investors need the ability to identify anomalies.

Limitations of financial indicators

Industry differences The same indicator may have different reasonable levels across industries. Real estate firms naturally have lower liquidity ratios; retail firms may have minimal accounts receivable. Blindly applying universal standards can lead to misjudgment.

Short-term fluctuations ≠ long-term trends Seasonal inventory buildup can temporarily reduce cash flow, but this is seasonal, not indicative of poor cash flow.

Static data cannot fully reflect dynamic changes Financial reports are cross-sectional; they cannot capture ongoing development. Comparing multiple periods is necessary to identify trends.

Conclusion: Financial reports are an important reference for investment decisions but should not be overly relied upon. Combine them with non-financial factors like industry outlook, competitive position, management team, and policy environment for comprehensive analysis.

▶ Other important information investors often overlook

Besides the four major reports, financial reports contain many easily overlooked but equally important pieces of information:

Operational Indicators Different industries have key non-financial indicators:

• Short video platforms: daily active users, video views, user engagement time
• Real estate: land acquisition scale, construction start and completion rates
• Insurance: first premiums, agent count, new business value

These indicators are directly related to core competitiveness and often better predict future performance than single financial metrics.

Development strategies and plans Information on future business plans, investment strategies, and market expansion helps investors envision the company’s prospects.

Dividend policy Mature companies adopt stable dividend policies, indicating:

• Stable profitability
• Sufficient cash flow
• Management confidence

TSMC’s shift from stock dividends to quarterly cash dividends marks its move toward maturity.

▶ Three main ways to efficiently access financial reports

1. Company official website

Most companies publish financial reports, earnings call recordings, and related materials in the investor relations section.

2. Stock exchange public information platforms

Listed companies are required to disclose official financial reports on the exchange’s website. For example, TSMC’s reports can be found on the Taiwan Stock Exchange website.

3. Professional financial information websites

Many financial sites offer financial report query and comparison tools, enabling investors to quickly filter and analyze.

▶ Final advice

Learning to read financial reports is an essential step to becoming an independent investor. By mastering the core logic of the four major statements, you can:

✓ Quickly assess a company’s profitability (Income Statement)
✓ Judge the company’s debt repayment risk (Balance Sheet)
✓ Examine the quality of the company’s earnings (Cash Flow Statement)
✓ Track the evolution of shareholders’ equity (Statement of Shareholders’ Equity)

But remember, financial reports are just the starting point of investment decisions, not the end. In an era of information explosion, investors need to develop comprehensive analysis skills—understanding not only the numbers but also how external factors like industry trends, policies, and market conditions influence the company’s future.

Continuous learning and practice will ultimately help you build your own financial analysis system.