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How to Read Financial Statements
By Kim Hyun-hee Reporter, Senior of Accounting
KOSPI is a stock index calculated based on the changes in the Korea Exchange, and it serves as a representative indicator of the flow of the Korean economy and stock markets. KOSPI exceeded 3,200 for the first time in three years and ten months, amid expectations of the Bank of Korea’s interest rate cut, the government’s supplementary budget and policies supporting the stock market. As a result, individual investors’ interest in stocks has also increased. The number of stock accounts rose by more than 1 million, while the average daily trading by individual investors increased by 30.55 percent for purchases and 32.1 percent for sales. As transactions expand, the liquidity of the stock market, which affects the formation of market prices. So, let us learn to way of the company’s investment.
Financial Statements
Investors can use financial statements to estimate future cash flows and assess a company’s financial health. Financial Statements include the Statement of Financial Position, Income Statement, Cash Flow Statement, Statement of Changes in Equity, and Notes.
The statement of financial position offers information on assets, liabilities, and equity. Assets refer to economic resources controlled by companies because of past events. Assets include cash and cash equivalents, accounts receivable from sales of goods or services.
Debts are present obligations of the company to transfer economic resources arising from past transactions. For example, they include accounts payable for credit purchases, advances received from customers before goods are delivered, and bonds payable issued to raise funds. Equity is calculated by taking away liabilities from assets. Equity includes paid-in capital, which is the total par value of shares issued by the company, and capital surplus arising from capital transactions. As such, the statement of financial position shows the company’s financial structure at a specific point in time.
In contrast, the income statement reflects a company’s operating performance over a specific period by reporting revenues and expenses. Revenues represent increases in assets or decreases in liabilities that result in an increase in equity, whereas expenses represent decreases in assets or increases in liabilities that reduce equity.
The cash flow statement illustrates cash inflows and outflows from operating, investing, and financing activities, and is used to assess a company’s actual cash-generating ability.
The Statement of Changes in Equity provides details on the size and composition of equity, as well as changes due to events like capital increases or dividends. Finally, the Notes clarify accounting policies, provide detailed breakdowns, and identify potential risks, all of which are essential for a comprehensive understanding of the financial statements.
These statements are accessible through the DART (https://dart.fss.or.kr/). They are issued periodically: annual (one year), semi-annual (six months), and quarterly (three months). These reports contain critical information such as changes in capital, company and business overview, risk management, major contracts, bonds, and corporate tax expenses. By analyzing these documents, investors can gauge a company’s financial soundness and evaluate its performance. This enables them to formulate investment strategies by comparing the company with other companies in similar industries.
Key Investment Indicators
Several investment indicators, derived from financial statements, are used to analyze companies. First, the Price to Earnings Ratio (PER) is calculated by dividing a company’s current stock price by its earnings per share (EPS). It indicates how many times the stock price is compared to the EPS. A higher PER relative to similar industries may suggest the company is overvalued. On the other hand, a lower PER could indicate an undervalued stock or a company in its early stages with high R&D expenditures, requiring a comprehensive analysis.
Next, the Price-to-Book Ratio (PBR) is calculated by dividing the market price per share dividing by the book value per share.
Book value per share represents the amount of a company’s net assets available to common shareholders after converting the company’s assets into their book value as recorded on the financial statements, and after subtracting preferred stock (shares with limited voting rights) and all liabilities, by the number of outstanding common shares (shares with voting rights).
PBR shows how many times a stock trades relative to its book value per share. A PBR of 1 means the stock price equals its book value; below 1 suggests undervaluation, and above suggests overvaluation. However, PBR alone does not guarantee a company’s financial soundness, as book value may not reflect the true market value of assets. In short, PBR is primarily an indicator used to evaluate stock prices based on a company’s financial health, while PER is used to assess stock prices in relation to profitability.
A company’s total capital consists of equity, which is funds raised from issuing shares, and debt, which is funds borrowed from external sources.
ROE represents how effectively management uses shareholders' capital to generate profits, calculated by dividing net income from the income statement by total equity. ROE indicates how effectively a company uses its own capital to earn profit. A high ROE tends to be associated with higher stock prices. ROE is a key financial ratio used to measure overall business performance. Conversely, a low ROE may indicate poor company performance or a struggling industry.
Company Analysis
Let's analyze which companies might be a better investment through financial statements as a hypothetical company.
From these figures, we can calculate PER, PBR, and ROE as follows:
Assuming companies A, B, C belong to the same industry. Company B has the highest PER, suggesting its stock price is high relative to its EPS, potentially indicating overvaluation. Company C has the lowest PER, and PBR, which might suggest it is undervalued or in an early investment stage with high R&D expenditures, requiring a thorough analysis of its financial statements. Assuming no errors in the financial statements, C appears undervalued based on its book value, while A is overvalued, and B’s stock price equals its book value. Company A boasts the highest ROE, indicating the most efficient use of shareholder capital to generate profits. In this case, investors may choose the company according to their personal inclinations. Those who prefer undervalued companies might consider Company C, as its low PER and PBR suggest it is undervalued relative to its EPS and book value. However, its lower profit growth compared to A necessitates a review of its operational performance and profitability. Aggressive investors seeking growth stocks might opt for Company B, which has the highest PER. This reflects market expectations for future growth despite a high stock price relative to current EPS. Therefore, investors should assess current performance and future growth potential when deciding whether to invest. Finally, Conservative investors seeking stability might choose Company A for its high ROE, reflecting consistent profitability. Thus, investors use these indicators to determine which companies to invest in and to what extent.
Other Considerations for Investment
In addition to these investment indicators, you can also refer to the ratio that shows a company's financial soundness and liquidity. For example, a high current ratio indicates sufficient ability to repay current liabilities. A high quick ratio indicates that a company has sufficient cash and cash equivalents, reducing its short-term financial risk. A high net working capital ratio suggests current assets exceed current liabilities, ensuring stable funding for operations. A low debt ratio indicates less reliance on borrowing and stable capital utilization. Lastly, a low non-current ratio indicates that current assets account for a larger proportion than long-term assets.
Warren Buffett advised to invest long-term in companies with intrinsic value higher than their market price and to invest in what you know. Ultimately, the most crucial things are a company's future growth potential and inherent capabilities. Additionally, assessing whether a stock is overvalued, financial soundness, cash management and debts levels will significantly aid investment decisions.
https://www.mk.co.kr/news/stock/11370848
https://www.mk.co.kr/news/world/11308403
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https://www.chosun.com/economy/money/2025/07/11/NZXWQXFM7FD4ZDSXNTEBSHL3X4Kim, S.-J. (2023). A Study on the Effect of Corporate Financial Stability on Stock Returns. Journal of CEO and Management Studies, 26(2), 293-313.