A zero-based budget accounts for every cent that you have in hand or in your bank account. Basically, it is a budgeting technique, which advocates that income minus expenses should be equal to zero. That is exactly where the method got its name from.
In case you are wondering, why this mode of financial planning does not approve of savings, the answer is that zero balance recommended by this technique does not mean that a person should essentially spend all the income. It is a symbolic term used to denote that you must maintain a record of every dollar you earn and assign a particular purpose to it.
Therefore, the money going in your savings account or towards debt payments, bills and purchases, will all be considered as an expense and subtracted from the incoming amount under the zero budgeting method. Basically, the concept is that no money should be left unallocated and you should be aware exactly where the smallest portion of your income was spent.
Many zero-based budgeting templates are available online, but you can do the basic calculation yourself. The procedure is explained in detail below.
Step-by-Step Guide for creating a Zero-based Budget
Calculate your entire Take-home Amount
This would include income after-tax deduction, additional earning from any side business or part-time job, money received in the form of benefits and grants such as child support, and any other form of incoming financial resources.
Adding them all together will give you the figure of total monthly income.
Calculate your Total Monthly Expenses
Similarly, pen down all the expenses and add them up to derive a figure for total expenditures.
This would mean listing down your fixed expenses such as rent, insurance premium, and subscriptions etc., as well as accounting for variable expenses such as groceries, car maintenance, and household items.
Besides these, there are unexpected expenses that pop up every now and then during the month but are not known at the start when the budget is usually made. In order to account for sudden birthday invitations (that would essentially require giving a gift), unplanned purchases, and fixing/replacing items that break, one must allocate a certain amount under the category of miscellaneous expenses. In case, unused resources are left in the miscellaneous head by month-end, those could be used to meet your goals ahead of time. For example, they can increase your monthly savings or help in repaying your debt much faster.
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Any amount set aside for savings should also be jotted down and added to all of these expenses to reach an accumulated figure for outgoing cash. The resulting value would be what we call total expenses.
Subtract Total Expenses from Total Income
If you have done the budgeting correctly, the answer should be zero. If it is not so, it means that either you have forgotten to add any expense, or the remaining amount should be categorized as savings. However, if the value is negative, it means that you are planning to spend more than your income and that needs to be adjusted. In order to do this, you will need to look for ways of cutting down on your budget, such as using discount coupons, carpooling rather than driving to work, and eating homemade meals instead of dining out.
Track your Spending
Once you have established a budget, you would need to monitor your spending throughout the month to see if it matches your plan. If not, you should try to make adjustments so as to get as close to “zero” as possible. However, if that seems difficult, careful observation and tracking will allow you to identify where you went overboard and help in setting the next month’s budget accordingly.
The image below may help understand the entire process better.
Though the calculation is easy and maybe conducted manually on a piece of paper or an Excel sheet, many people look for templates to speed up the process and make their lives easier.
Below is one of such templates that you may find useful:
|Total Budgeted Income:||
|Retirement (15% of income)||0.00||0.00|
|Debts||Credit Card Payment 1||0.00||0.00|
|Credit Card Payment 2||0.00||0.00|
|Department Store Card||0.00||0.00|
|Total Set Expenses:||
|Total Adjustable Expenses:||
|Total Budgeted Income||0.00||Actual Monthly Income||0.00|
|Total Budgeted Expenses||0.00||Actual Monthly Expenses||0.00|
|Total Budgeted Balance||0.00||Actual Monthly Balance||0.00|
The above “Total Budgeted Balance” number should equal zero
Even though our sample templates and examples mostly revolve around the budgeting of household expenditures, this technique may be used for planning any activity requiring financial resources; such as travel or office expenses.
Is Zero-based Budgeting possible with an irregular income?
Contrary to general belief, it is possible to use this budgeting technique even if the income you generate is irregular in nature. An irregular income is one that varies in amount. The money earned might be comparatively more for one particular month and less in the other. Businesses that are seasonal and sell products that have a high demand during a certain time of the year usually result in irregular income.
In order to create a financial plan for such earnings, it is recommended to first prepare a budget for a low income period. The trick is that when you get a higher income, you can distribute the amount amongst different headings already created in your list, as per need basis.
If the amount you earn is not sufficient to cover all the desired expenses, you may start with the absolute necessities and move towards less essential needs when you get the additional amount.
A similar approach can be adopted with commission-based income as well.
Can Zero-based Budgeting be used for Future Planning?
Despite the fact that this method of planning finances seems to be limited to the period it covers, and hence is deemed unfit for future planning by many, the reality is quite opposite.
Let’s consider you want to save a certain amount by December for Christmas expenditures. You can start allocating a certain portion of your income to expenses under the savings head right from January. This means that even though your income minus expense would account for zero every budgeting period, you will still have the required savings accumulated.
Pros and Cons of Zero-based Budgeting
It keeps you informed about your expenditure: income ratio at all times. Thus, the chances of going overboard are minimal. This is a useful method of remaining on track for those who have a hard time limiting their purchases.
Also, this method can be customized for budgeting any activity to accommodate different types of income-generating arrangements.
The method takes a lot of time on part of the user as it requires monitoring the amount spent on each and everything and then recording it, either in your own format or on zero-based budgeting templates.
Zero-based budgeting may be problematic for people like freelancers who have an unpredictable income. Such people would be unaware of the total amount that they will earn each month, hence unsure of how much to allocate to each head. One technique for such people who plan to use a zero-based budgeting method is to use the previous month’s total earnings as an estimate.