Calculating Cash Flow for Freelancers: Formula and Example

On paper, things are going well: the orders are coming in, the report from your tax advisor shows a profit, the invoices have been sent. And yet, at the end of the month, your account is surprisingly empty. If that sounds familiar, you're probably missing a number that doesn't appear in any profit calculation: your cash flow.

Cash flow shows how much money actually came into your account over a given period – and how much went out again. Not what you earned, but what you have. Here you'll find the formula for operating cash flow, a fully worked example and a clear explanation of how it differs from profit.

What cash flow measures

Payments, not bookings

Cash flow (literally: the flow of money) looks exclusively at payments. An invoice you send in March only matters for cash flow once the money lands in your account in April. A depreciation charge that lowers your profit doesn't appear in cash flow at all, because no money changes hands.

That's exactly what makes the number so useful: it matches your account balance. If cash flow is positive, your balance grows. If it's negative, it shrinks.

Three types of cash flow

Cash flow is traditionally split into three areas:

• Operating cash flow: money from day-to-day business. Customer payments in, running costs out.
• Investing cash flow: money spent on purchases like a laptop, camera or office equipment – and proceeds if you sell something like that.
• Financing cash flow: loans, repayments, owner contributions and owner drawings.

If you're a solo freelancer or run a small business, operating cash flow is the most important of the three. It answers the question: does my business support itself?

The formula for operating cash flow

The direct method

For freelancers, the direct method is the most practical, because you can read it straight off your bank statement:

Operating cash flow = cash received from day-to-day business − cash paid out for day-to-day business

Cash received means all customer payments that arrived during the period you're looking at. Cash paid out means all running business expenses you actually paid during that period: rent, software, insurance, outsourced services (e.g. freelancers you've hired), travel costs, phone and so on.

Equipment purchases, loans and your owner drawings don't belong in operating cash flow. They fall under the other two areas – and they're the reason a positive operating cash flow can still end in a falling account balance. More on that in a moment.

The indirect method

The indirect method starts from profit and adjusts it for everything that isn't cash: depreciation is added back, outstanding receivables are deducted, unpaid bills are added on. It's common in the annual accounts of companies that prepare a balance sheet, but it's cumbersome for steering your business month to month. Stick with the direct method – your bank statement is the best data source you have.

Worked example: profit and cash flow in the same month

The following example is entirely made up. It shows the month of April for a self-employed consultant who works with payment terms. The "Profit calculation" column shows a business view based on the date of invoicing, as is usual under accrual accounting. All amounts are net; VAT is left out for clarity.

What the table shows

Profit in April is €5,500. Operating cash flow is €2,800 – positive, so the business supports itself. And yet the consultant has €4,000 less in her account at the end of the month than at the start. Four things create the gap:

1. Payment terms: she issued €8,000 in invoices but received only €5,200. The rest is tied up in outstanding receivables and won't arrive until the coming weeks.
2. Laptop: the purchase costs €2,000 right away. In the profit calculation, only an illustrative pro-rata depreciation of €100 shows up here – how a device is actually depreciated is something to clarify with your tax advisor.
3. Tax prepayment: the €1,800 is purely an assumption for the example. Income tax doesn't reduce business profit, but the money is still gone in April.
4. Owner drawings: €3,000 for rent, groceries and health insurance. That's not a business expense, but it's real money leaving the business.

None of these four points is a mistake. They're normal, and the tax amounts are pure assumptions. If you determine your profit using cash-basis accounting (Einnahmen-Überschuss-Rechnung), you already work on a cash-in, cash-out basis for your regular income and expenses. Point 1 then disappears, and the difference from cash flow comes mainly from depreciation, purchases, tax payments and owner drawings. They only become visible if you calculate your cash flow and not just your profit. To see how deep the difference between the two figures goes, read the article Profit on paper, but no money?.

Calculating cash flow as a freelancer: step by step

1. Set the period

For freelancers, the month is the right unit. A quarter blurs too much, a week is too granular. Note your account balance at the start of the month.

2. Sort your bank statement into categories

Go through every transaction and assign it to one of four groups: cash received from the business, running business expense, investment, or financing (including owner drawings and income tax prepayments). VAT payments to the tax office count as running cash outflows. Treating income tax as a private outflow here is a simplification for your planning – for a sole proprietorship, it's essentially an owner drawing. If you use several accounts, combine them all.

VAT deserves a closer look of its own: the money is sitting in your account, but it isn't yours. The cleanest approach is to separate the VAT you've collected, either mentally or in a sub-account. THA·ONE is a planning aid, not tax advice within the meaning of the German Tax Advisory Act (StBerG) – which tax payments you'll face, how much and when, is something to clarify with your tax advisor.

3. Calculate and cross-check

Cash received minus running cash paid out gives you operating cash flow. If you then factor in investments and financing (inflows plus, outflows minus), you get the change in your account balance. The check is simple: opening balance plus change must equal the closing balance on your bank statement. If it doesn't, a transaction is missing.

If you first want a rough picture, you can start with the free liquidity quick check.

4. Look ahead

The cash flow of the past few months is history. It gets interesting when you estimate it for the months ahead: which invoices will be paid when, which costs are coming up, when are tax prepayments and annual fees due? That's how a liquidity plan takes shape – you'll find a template under Creating a liquidity plan. If you want to map seasonal fluctuations and different scenarios along the way, a tool like THA·ONE's liquidity tool takes the number-crunching off your hands.

Typical mistakes when calculating cash flow

Confusing revenue with cash received

An invoice you've sent is a promise, not a payment. If you count the invoice amount in your head, you'll regularly overestimate your cash flow – especially with clients who have long payment terms.

Forgetting irregular payments

The annual bill for professional liability insurance, tax prepayments, the new notebook: items like these come up rarely, but they're big. In a pure month-by-month view, they don't appear for eleven months and then tear a hole in the twelfth. Spread them mentally across all months or set them aside as a reserve.

Leaving out owner drawings

Many freelancers calculate their business's cash flow and then wonder why there's still nothing left over privately. Owner drawings belong in the calculation – ideally as a fixed monthly amount you treat like a salary.

Only looking back

A negative cash flow last month is information, not a catastrophe. It only becomes critical when it continues over several months and no reserve cushions it. That's why looking ahead matters more than looking back.

Conclusion

Operating cash flow is the number closest to your account balance: cash received minus running cash paid out, read off your bank statement. It shows whether your business supports itself – regardless of what the profit calculation says.

Profit remains important, for tax purposes and for the question of whether your business model works. But whether you can pay next month's rent is decided by cash flow. Calculate it once a month, include investments, taxes and owner drawings, and estimate it for the months ahead. Then the empty account is no longer a surprise, but a number you saw coming.