$8,500

2,000

5,000

1,500

The balance sheet lists assets and corresponding claims (liabilities and equity).

Any asset has a source, so assets balance with claims.

That is why total assets equal total claims (liabilities and equity).

The statement of cash flows has the following format:

$3,000

(1,000)

2,000

5,000

(500)

8,500

0

The statement of cash flows explains how the company obtained and used cash during a period.

Sources of cash are called cash inflows , and uses of cash are known as cash outflows .

Cash inflows are sources of cash; for example, payments from customers, capital acquisitions, etc.

Cash outflows are uses of cash; for example, payments to vendors, paying off bank loans, etc.

To better understand effects of transactions on financial statements and see connections between financial statement elements, a statements model was created.

The two forms of such a model are vertical and horizontal. As its name implies, the vertical model arranges financial statements elements from top to bottom on a page.

Horizontal, on the other hand, is so named because it arranges financial statements elements horizontally across a page.

In the horizontal model, the balance sheet is presented to the left, followed by the income statement, and the statement of cash flows.

Let us demonstrate the usefulness of the horizontal model and apply it to the five transactions we covered before.

Note that if a transaction does not affect the model, a related cell will show "n/a" in it.

In the statement of cash flows, FA means cash flows from financing, IA means cash flows from investing, and OA means case flows from operating activities.

+

1

5,000

=

n/a

+

5,000

n/a

-

n/a

=

n/a

5,000

FA

2

2,000

=

2,000

+

n/a

n/a

-

n/a

=

n/a

2,000

FA

3

3,000

=

n/a

+

3,000

3,000

-

n/a

=

3,000

3,000

OA

4

(1,000)

=

n/a

+

(1,000)

n/a

-

(1,000)

=

(1,000)

(1,000)

OA

5

(500)

=

n/a

+

(500)

n/a

-

n/a

=

n/a

(500)

FA

Totals

8,500

=

2,000

+

6,500

3,000

-

(1,000)

=

2,000

8,500

With respect to Events No. 1 and 2, it is clear that only the balance sheet and statement of cash flows are affected.

There is no effect on the income statement.

Furthermore, you can see that Event No. 1 increases assets and equity and that the cash inflow is defined as a financing activity. Event No. 2 has a similar effect, except that liabilities increase instead of equity.

Event No. 3 affects three financial statements.

Assets and equity increase on the balance sheet.

The recognition of revenue causes net income to increase, and the cash inflow is shown as an operating activity on the statement of cash flows.

Event No. 4 is the opposite of Event No. 3.

Assets, equity and net income decrease.

Cash flow statement shows this decrease as an operating activity.

Finally, Even No. 5 acts to decrease cash and equity.

The cash distribution is not shown anywhere in the income statement.

That's because distribution is not an expense and thus, is not included in the determination of net earnings.

Cash distribution is categorized as a financing activity in the cash flow statement.

Using horizontal model helps a lot in understanding the effects produced by each event, so it is advisable to use it as often as possible while learning principles of financial accounting.