Zero-Based budgeting is an essential money-management tool, which is why everyone should have a budget. Even though most Americans understand the importance of having their expenses be less than their income, only 67% of them have a budget to monitor money. So, where does the problem lie? Perhaps you do not use a budgeting method that fits you and your lifestyle.
If you follow traditional budgeting strategies, you need to determine how much money you plan to earn and how much you plan to spend. One reason why this strategy might not work is that you only have assumptions about your finances. With Dave Ramsey’s envelope budgeting, for example, you need to physically track your expenses and carry all your cash in envelopes with you. Such a method Is not ideal for everyone. Perhaps other types of budgeting will be a better fit, such as the zero-based budget?
With this method of budgeting, you spend every dollar you make. In other words, each dollar has a purpose, and you spend it productively.
Read on to learn more about a zero-based budget, its advantages and disadvantages, and how to create one.
What is Zero-Based Budgeting?
Zero-based budgeting (ZBB), or zero-sum budgeting, is a method of monthly budgeting where you allocate your income towards your expenses, savings, and debt payments until you reach zero. You give every penny you earn a job so that, at the end of the month, you can account for your entire income. Your monthly income and your monthly expenses match.
You create monthly expense categories, which you can repeat or mix up as necessary. Let’s say that after you subtract your expenses from your income, you have $300 extra. You don’;t leave that money in your checking account. The goal is to give that money something to do. You can use that cash to add to an alternative savings group, such as your emergency fund or your retirement account, or to discretionary expenses or paying off debt.
You can continue to make adjustments to your budget and allocate funds differently as needed for all of your money goals.
Pro Tip: Parenting Money Tips
How to Create a Zero-Based Budget?
Perhaps the main reason why so many people don’t budget is that they feel that budgeting restricts them. Despite this common belief, implementing the right budget plan gives you more freedom and financial control. Creating a zero-based budget that fits your goals, finances, and lifestyle requires patience and time. With this flexible and customizable budgeting, you will soon see your debt decreasing and your savings increasing. Here are the steps you need to follow towards getting there.
Start with Your Income
Take a pen and a piece of paper and start writing down your monthly income. If you wish, you can also use a budgeting app, such as Mint. Income is all the money coming into your home’s bank account, including your monthly paycheck, side hustle income, residual income, child support, benefits, etc. After you identify the sources of your income, add them up to learn how much money you have.
If you earn the same amount of money each month, this won’t be difficult to do. However, if you don’t have a predictable income, you might need to put in the extra effort to calculate your income. You can use your average income amount as a base. If you earn more than your average amount one month, put that money aside for when your income is lower than you expect. That way, you can still budget in a month when your income is below your average income.
‘Additional Topic: Student Loan Repayment Plans
List Your Monthly Expenses and Spending
After you determine your after-tax income, it’s time to monitor your spending habits and calculate what you spend every month. You need to know how you are spending your money and where each dollar goes. That way, you will spot areas where you can cut back and allocate that saved amount to other categories.
Start with focusing on essential or fixed expenses, such as food, utilities, mortgage (or rent), and transportation. These expenses are usually steady, so you will know how much money you spend on them.
Next, once you have tackled the fixed expenses, think about all the other expenses you have each month. Write down common variable expenses like clothing, restaurants, and entertainment. Check your bank statements to see how much money goes towards these discretionary purchases. Since your needs change from month to month, you should make a spending plan each month. The key is to get started, even with small steps, so that you don’t get overwhelmed at the outset.
Finally, do not forget to track expenses that aren’t monthly. These will include holidays, anniversaries, birthday gifts, car insurance, taxes, and other seasonal costs into your monthly budget. You could plan setting aside a little bit each month to cover these costs.
Create Expense Categories
When creating a zero-based budget, you need to identify your expenses and priorities, including an emergency fund, debt, savings goals, investments, and your wants and needs. Categorizing is different for each person; yours will depend on your goals. For example, some people want to prioritize eliminating debt, while others want to focus on padding their emergency fund. Some might want to focus on your retirement contributions since it can be challenging to build up the recommended 8 – 12 times the value of your pre-tax income to retire. People who want to go on a vacation will set up a travel fund. Those who want to buy a new car will make a car fund, etc.
Remember, your income minus expenses needs to equal zero. So make sure you create categories that will ultimately include all your expenses so that you can account for every dollar.
Here is an example of categorizing when your average income is $3,500. Expenses and categories include
- $1200 towards housing costs (utilities, mortgage, car insurance, etc.)
- $450 for food
- $250 for transportation
- $200 for healthcare costs
So far, you have spent $2100 of your $3,500 income on necessities. You still have $1,400, and you need to find its purpose. Some people might mindlessly spend the extra money on dining out, new shoes, or other luxuries. Since you are creating a zero-based budget, you will give that sum a job. For example, you can put $500 towards your retirement or savings account, allocate $200 for dining out, and put the remaining $700 toward your student loan or other debt. You have met your one goal: no dollars left over in your budget.
If you are spending more than you make, like 46% of Americans do, you need to work on cost savings; you need to cut back expenses. For example, you can share a ride with your coworkers, make your coffee instead of buying it, sell some items you haven’t used for a long time, etc. If you are spending too much on groceries, you can use coupons or switch from brand-name products to generic ones.
Related Article: How to Buy a Car
Keep Track of Your Budget
The only way to know if your zero-based budget is working is to track it. If your spending matches your plan, you will start saving throughout the month. However, meeting a zero goal might take some practice, so don’t be discouraged if you don’t balance your income and expenses out right away.
An efficient zero-based budget is the one you rely on every month, but one that allows you to make adjustments if necessary. You can move funds from one spending category to another. It is flexible, and you can adapt it to your needs.
What If You Have an Irregular Income?
If you are a freelancer or your income is based on a commission, you might have an irregular income. The good news is that, even if you have irregular income, you could still work with zero-based budgeting. You should base your budget on an income amount that is the lowest you could earn in a month. You should start with necessary expenses (food, housing, medical costs, and transportation) and then move on to other expenses in order of decreasing importance.
If you fail to cover everything, don’t worry. Focus on the most basic expenses for now. When the next paycheck arrives, cover the costs you haven’t from the previous month. If you still have extra cash after covering those expenses, you can think about saving more or putting more towards debt payments.
You can apply the 50/20/30 rule here. According to this rule, you assign 50% of your income towards needs, 30% towards wants, and 20% towards savings and debt repayment.
The Benefits of Zero-Based Budgeting
Implementing a zero-based budget has several advantages. Let’s discuss a few of them.
Zero-Based Budgeting Keeps You Aware of Your Spending
When you switch to zero-based budgeting, you track your expenses. This part of the budgeting process keeps you aware of how much money you spend and where that money goes. As a result, it helps you keep your spending under control so that you don’t spend money you don’t have. You will also find budget areas that need to be adjusted, either by cutting back on spending or earning more, in order to save money or pay down debt. The best part is that you don’t have to be aggressive about cutting costs.
Zero-Based Budgeting is Flexible
If managing money is new to you, then you will love zero-based budgeting. It is flexible and customizable, easily fitting your financial situation. You set your financial goals and work your budget around them. You spend and save on your terms. Plus, you no longer have to live from paycheck to paycheck, stressing out and wondering how you’ll cover your monthly expenses or cope with an unexpected cost.
Zero-Based Budgeting Helps You Create Healthy Financial Habits
People stress over finances even when they have savings and don’t have excessive debt. That’s because they probably don’t know what their income is, where their money goes, and in which areas they overspend. Zero-based budgeting helps you see the bigger picture by taking a detailed approach to your financial goals. Examining your spending will help you cut back.
For example, you probably spend a few hundred dollars on eating out or on impulsive purchases. Once you create categories and start tracking expenses, you may gradually begin to prepare meals at home and stop buying clothes or other items you do not need. You may not even notice that your spending habits have changed for the better.
The Disadvantages of Zero-Based Budgeting
Zero-based budgeting has many advantages, but it also has a few drawbacks. Let’s check them out.
Zero-Based Budgeting Can Be Time-Consuming
Building and implementing a zero-based budget is a time-consuming budget process. You need to monitor your spending and track every expense. Moreover, things can get complicated when tracking variable expenses, such as holiday purchases. You can solve this by setting aside money for such costs. Luckily, budgeting will become more efficient after a few months as it becomes routine.
Zero-Based Budgeting is a Bit More Challenging if You Have an Irregular Income
Zero-based budgeting is doable, even with an irregular income; however, when income fluctuates, it might take more time and effort to implement the budget. If you have an irregular income, perhaps you should focus your attention on padding your emergency fund to make your budget work during the months when the money coming in is low.
Zero-Based Budgeting Software Apps
Some people prefer using a pen and paper when creating a budget. Others find using budgeting software apps to be more accessible and more effective. Here are the most popular budgeting tools you can use to set up your zero-based budget.
You Need A Budget (YNAB)
With YNAB, you give every dollar you have an actual job. With this budget app, users can create an income-based budget where each dollar has a different task. Some people may work towards debt payments, while others focus on living expenses. YNAB comes with a 34-day free trial. The standard cost is $6.99.
EveryDollar
Financial guru Dave Ramsey and his team have built the EveryDollar app that works on the premise of assigning every dollar a job. It connects your budgeting to your bank account to give you an idea of where you stand financially. The app offers eight spending categories and has the option of adding categories. You can make use of a free version or the paid version ($99).
Mint
Mint is a budgeting app that connects to your bank account and tracks your income and your spending. It tracks your bills and alerts you when you are late with a payment or when you are spending too much. It also provides you with access to your credit score and gives you tips on how to improve it. You can connect the app to your savings account, credit card account, and other personal financial platforms. Mint is free.
Zero-Based Budget for Businesses
Both small businesses and multinational corporations have been implementing zero-based budgeting as a simple approach to business management. This type of budget requires companies to build their annual budget from the ground up. The goal of the zero-based budget is cost savings aimed to drive growth and finance future initiatives. Managers and executives analyze every dollar, track monthly financial performance, and establish a cost management culture and cost awareness among employees. As opposed to traditional budgeting, in which managers analyze only new expenses, zero-based budgeting requires justification of old expenditures in addition to new ones.
The zero-based budgeting process focuses on identifying cost drivers and using that information to create realistic budget goals. The procedure removes expensive costs and allocates those savings to areas that will drive future business growth.
Tip: How to Pay for College in 9 Steps
Is Zero-Based Budgeting Meant for You?
Now that you are familiar with the basics of zero-based budgeting and how it works, you can try it out. It is a mindset, and you need to make an effort and invest time and patience to make it work. In case you don’t find it handy and it doesn’t meet your specific needs, you can switch to a different budgeting method. If you are facing financial difficulties or you are struggling financially, it would be wise to visit an accredited financial advisor.
What do you think? Have you tried zero-based budgeting? Do you want to try it? If you have another budgeting method that works for you, please tell us more about it!
Not Done Reading? Read Ways to Cut Wedding Costs