The Keys to Reading Consolidated Financial Statements - A Brief Introduction

In recent years, numerous Taiwanese companies have responded to competitive pressures by internationalizing and diversifying their businesses. Whether to better position themselves in their main markets or improve their production arrangements, many have established overseas (and domestic) investment holding companies, branch companies and manufacturing centers. These investee companies are formally independent legal entities, but in terms of operations and risk assessment, they are really part of a larger enterprise. Given how difficult it is to get the "big picture" from unconsolidated, stand-alone financial statements, consolidated financial statements are gradually becoming the main financial statements such group enterprises issue.

When individual financial statements are adopted, a controlling company's financial statement need not show the total assets, liabilities, revenue and expenses of its subsidiaries, so the important thing about consolidated financial statements is that they allow you to see the subsidiaries' assets, liabilities and income/loss. Preparation of consolidated financial statements involves abstruse accounting theory and principles making it difficult for users without an accounting background to understand their contents. General readers of financial statements may be able to use the following key points to extract useful information:

1. Sales revenue / gross profit
   Since sales and purchases between parent companies and subsidiaries are written off in consolidated financial statements, what you see are external sales by the consolidated entity. Therefore, financial statement users can compare sales revenue and gross profit from sales in the consolidated statements against those in the unconsolidated statements. With a little analysis, it is possible to assess the prospects for earnings distributions and understand the corporate group's true total costs, total expenses, or profit conditions in the company's industry.
   
   
   
2. Accounts receivable and notes receivable
   When consolidated financial statements are prepared, receivables with subsidiaries are first written off, and then subsidiaries' receivables are incorporated into the consolidated statement. Readers can easily analyze the corporate group's accounts/notes receivable turnover and make sense of its allowance for uncollectible accounts and its account factoring situation.
   
   
   
3. Inventory / fixed assets
   Readers of consolidated statements can use the information on subsidiaries' inventories and fixed assets to see if the inventory and fixed assets of the entire group are reasonable given the nature of the group's industry, and if stocks are consistent with actual business operations. One may also assess the group's overall inventory turnover rate and losses from market price declines and obsolete and slow-moving inventories.
   
   
   
4. Goodwill
   When a parent company acquires another company's shares, the amount paid often exceeds the net value of the company's equity, and the difference between what the acquirer pays and the net fair value of the acquired company's assets is what is referred to as goodwill. Financial statement readers can use the consolidated statement to find out the acquired subsidiary's goodwill, subsequent loss of goodwill and related information.
   
   
   
5. Group-wide debt service capacity
   Under some circumstances, a parent company will provide guarantees to financial institutions so that its subsidiary can obtain financing for the operating capital it needs. Financial statement readers must pay close attention to subsidiaries' offshore financing risk. Because the consolidated statements brings together subsidiary borrowing information, they make it easy for users to analyze a company's debt ratio and actual debt service capacity.
   
   
   
6. Cash flow
   When financial statements are consolidated, one should look carefully at major cash inflows from operations and cash outflows for capital expenditures, as well as annual aggregate financing and repayment circumstances.
   
   
   
7. Notes to the financial statements