Companies with two sets of financial statements: consolidated and separate

Open a listed company's annual report on DART, Korea's electronic disclosure system, and there is often more than one set of financial statements. The consolidated financial statements come first, and the separate financial statements are attached after them. It is the same company and the same year, yet sales and profit differ.

At first it is natural to ask which one is real. Both are. They simply count different things. Consolidated statements combine the company with the subsidiaries it controls into one unit; separate statements look at the company on its own.

The difference is most dramatic at holding companies. A holding company does not run a business directly; it holds stakes in subsidiaries. On a separate basis its sales consist of little more than dividends and brand royalties, so the holding company of a group worth trillions of KRW shows sales of a few hundred billion KRW. On a consolidated basis, the same company shows the sales of the whole group.

Copying the numbers without knowing which set they came from leads to a completely wrong picture of the company. This article sets out what the two tables count differently, which metrics diverge as a result and how, and which one Jupick uses.

Consolidated financial statements treat the controlling company and the companies it controls as one economic entity. Legally they are separate companies, but where one can direct the management of the others, they are treated as effectively one body and their numbers are combined.

Combining is not simple addition. Transactions within the group are eliminated. If the parent supplies parts to a subsidiary, the group as a whole has not yet made a sale to anyone outside, so that revenue is removed. Without this step, affiliates could inflate sales just by passing goods back and forth.

If a subsidiary is not 100% owned, one more item appears. Assets and sales are combined in full, but the part of profit that belongs to other shareholders is shown separately. So the bottom of the consolidated income statement splits profit into the part attributable to owners of the parent and the part attributable to non-controlling interests. The accounting standard sets the first of these as the numerator for earnings per share.

The advantage of consolidation is clear. It shows the full size of the business the company actually runs. Problems piling up at a subsidiary have nowhere to hide. That is why consolidated figures are the default for understanding a company that operates as a group.

Separate financial statements do not combine subsidiaries. Instead, the stakes in subsidiaries appear as a single line of investment assets. There is a choice in how to value those stakes; the methods in use include keeping them at acquisition cost and reflecting changes in the subsidiary's equity.

So not a single KRW of a subsidiary's sales appears on the separate income statement. Only the dividends received from subsidiaries come in. However much a subsidiary earns, the parent's separate profit stays the same unless the subsidiary pays a dividend. Conversely, the separate income statement can stay quiet even when a subsidiary posts a large loss.

That does not make the separate statements useless. For dividends, they are actually what is needed. A company pays dividends out of its own retained earnings, and those retained earnings are a figure in the separate financial statements. However large consolidated profit is, no dividend comes out if the parent itself has nothing to pay it from.

Taxes and legal liability are also assessed company by company. What creditors look at is the assets of that legal entity, not of the whole group. The two tables do not replace each other; they answer different questions.

If consolidated and separate figures differ, every metric calculated from them has two values as well. The debt ratio, operating margin, revenue growth and return on equity all do.

The debt ratio is the clearest case. Money borrowed by a subsidiary counts as group debt on a consolidated basis but is invisible on a separate basis. For a company with several subsidiaries that grew on borrowed money, the consolidated debt ratio is high and the separate debt ratio is low. The judgment of financial stability for the same company can come out the opposite way.

Operating margin splits too. A holding company's separate operating margin often comes out abnormally high, because its sales are only dividends and royalties, with almost no cost attached. Set that figure next to a manufacturer's operating margin and the comparison does not hold.

Return on equity is more subtle. If a subsidiary stake is carried at acquisition cost on a separate basis, book equity stays at an old price no matter how large the subsidiary grows. With the denominator fixed and only dividend income coming in, the ratio drifts away from actual profitability.

So when comparing two companies' metrics, there is something to check before the values: whether both came from the same basis. Setting a consolidated debt ratio against a separate debt ratio and calling one company more stable is like comparing lengths measured with two different rulers.

Jupick takes financial metrics for Korean stocks from annual reports filed on DART. It looks for the consolidated financial statements first and falls back to the separate statements if there are none. A company with no subsidiaries does not prepare consolidated statements at all, so the separate statements are its only source.

The reason for putting consolidated figures first is the one given above. Consolidated statements show the size and burden of the business the company actually runs, and they leave subsidiaries no place to hide problems. To say the grade reflects financial condition, that condition has to include the whole group.

This rule has one consequence worth stating plainly. The debt ratios of Korean stocks shown side by side are not all on the same basis. Most are consolidated, but some are separate, because the list includes companies with no subsidiaries that do not prepare consolidated statements.

That is hard to call a problem. For a company without subsidiaries, consolidated and separate statements are the same table, so the split in basis makes no practical difference. The problem case is a company that has subsidiaries but whose consolidated statements could not be obtained, so the data fell back to the separate statements. For such stocks, debt can look lighter than it really is.

Among the flags Eurostat, the statistical office of the European Union, uses for country statistics, there is one that means “definition differs”: the value exists but was calculated under a different definition. That a statistics agency sets up a dedicated code shows how common and serious the problem is. Jupick does not yet mark consolidated versus separate on individual stock pages. For now, this article and the methodology page fill that role.

When opening financial statements yourself, the first thing to check is not a number but the title of the table: whether it is consolidated or separate, and which period it covers. Numbers read without checking these two things cannot later be traced back to where they came from.

When comparing several companies, use one basis for all of them, especially if holding companies are in the mix. Put a holding company's separate figures next to an operating company's consolidated figures and even the scale of sales is off by orders of magnitude.

There is also a trap when following one company over time. When a company acquires or disposes of a subsidiary, the scope of consolidation changes, and that year's rise or fall in sales may reflect a change in what is counted rather than growth or shrinkage of the business. When revenue growth suddenly jumps in a given year, it is better to check first what the company acquired or disposed of that year.

Finally, this article does not say either table is better. Consolidated statements answer questions about the size of the business; separate statements answer questions about the legal entity itself. Seeing the source of dividends takes the separate statements; seeing the group's burden takes the consolidated ones. The task is not choosing one but knowing what question is being asked.

This content is for information only and is not investment advice. Jupick gives no trading advice on any stock and does not forecast future results or prices, and a metric looking good or bad on a consolidated or separate basis is not advice of any kind. Investment decisions and responsibility for them rest with the user.