Goodwill is an accounting measure of a business's popularity and strength in its market. While goodwill's value on a company's books may be decreased due to market conditions, the only way this asset can be increased is through the business's acquisition of a subsidiary. It is the subsidiary transaction that will affect the cash-flow statement, but only if the business used cash to pay for at least part of the acquisition price.
When a business forms, it's not merely a collection of assets and employees. As an organization conducts its business, it builds a reputation that people recognize. The reputation can come either from being accredited, such as by being a lawyer or CPA, or by having good customer relationships. The value of that brand goes beyond the business's products and assets. Goodwill is an accounting measure meant to place a price on that intangible value of a business. Goodwill is a long-term, intangible asset for balance-sheet purposes.
Advertisement Article continues below this adIf the market value of the business increases to an amount greater than goodwill, the asset cannot be increased to reflect that new value. The only way goodwill can be increased is through the acquisition of another company as a subsidiary. Assume a business acquires a subsidiary for a price that exceeds the total value of the subsidiary's assets. The difference between the acquisition price and the value of the subsidiary's goods will be recorded as goodwill on the business's consolidated balance sheet.
The cash-flow statement keeps track of the cash generation and use by specific business functions during a period of time. The three major categories of a cash-flow statement are: operating activities, investing activities and financing activities. Operating activities are those that are associated with the normal course of business, such as selling goods and services. Investing activities relate to money spent acquiring investments, such as stock, and the income generated by those assets. Financing activities relate to the process of acquiring funds, such as through bonds, and paying off those obligations.
Advertisement Article continues below this adAn increase in goodwill will only affect the investing and financing activity sections of the cash-flow statement if the purchase was at least partially paid for with cash. The cash-flow statement reflects the cash paid for the entire subsidiary -- not just goodwill. Any part of the purchase price for the subsidiary that was paid for using cash is recorded as a negative amount on the investing activities section in the year of the acquisition.
Sometimes a business will issue debt to obtain the cash to purchase a subsidiary. In that case, you would increase cash flow from financing activities by the amount of cash obtained from the loan the year the debt was issued. In future years, you would decrease cash flow from financing activities by the amount of service payments made on the long-term debt. Service payments include all interest and principal pay-down payments made.