Introduction

Nearly every day 23 million Canadians wake up, put on their shoes, and head to work at some point in their week. People work so they can afford the things they want and need. Most of us need to pay for the housing, heating, food, clothing and water we need to survive. Many of us want things, such as TVs, cell phones, and vacations. Businesses are the form in which we achieve this system. Businesses such as hospitals, farms, utility companies, Coca-Cola, Sony, and GM are able to generate billions of dollars by producing goods and services to meet our needs and wants.

Does generating money simply mean that a company is successful? Many companies have generated billions in revenues and still suffered bankruptcy (e.g. Nortel). How do we know a company is actually doing well? If you are comparing two companies each with annual revenues of $10 million, how do you know which is more profitable, or which you would like to invest in? How is the information on a company’s performance recorded and how can it be used to determine a company’s profitability? If you run your own business, how would you describe your company’s financial performance over the last year?

Imagine you operate a business that specializes in making tires for transport trucks. You sell each set of tires for $500 and in your first month of business you sell 100 sets; you generated $50,000! How much did you spend making those tires though? To produce each set, you need to spend $200 on aluminum alloy and $50 on rubber. This means you made $250 from each set, right? You also have to pay rent on the factory in which you produce the tires, salaries for the employees who make the tires as well as the administrative staff, and utilities for plant operations. How does this affect your earnings? Do you have enough money each month to purchase supplies or do you have to borrow to do so? Do you know if you are earning a profit? How would you describe your company’s financial performance over the last year to a potential investor? Will you have to pay taxes?

In this chapter, we will find answers to these and other similar questions using financial statements of the company. We will discover what these statements are, what their purpose is, what information they contain and how it can be used to perform analysis of company’s activities. We will also discuss how financial statements can be used in forecasting of a company’s performance. We will finish this chapter by examining taxation in Canada.

Key Concepts

• Financial statements (income statement, balance sheet, cash flow statement)
• Financial ratios (profitability, debt management, liquidity, asset management, market value)
• Pro forma financial statements
• Taxation
• Depreciation

Learning Objectives

After completing this chapter, students should be able to:

• Understand financial statements and use them to find important financial information
• Use financial ratios to evaluate a company’s financial performance
• Understand pro forma financial statements
• Calculate income taxes based on Canadian taxation laws
• Calculate depreciation expenses using the three primary methods and apply CCA rules