Zero-Based Budgeting: How it WorksPublished on April 16, 2021 by Daniel Azzoli
Budgeting can be a tricky task, especially when you’re going into it without a concrete system in place. So, if you’re looking to focus your budgeting efforts, improve your spending habits, and save more money, zero-based budgeting might give you the framework you need to accomplish your financial goals!
The main aim of this budgeting system is to bring a high level of detail to what you do with every single dollar that goes in and out of your hands, and to make sure you’re intentional with what you do with your funds.
Today, we’re going to talk about what zero-based budgeting is, detail how to go about implementing it, and talk about how it might be able to benefit you.
What is Zero-Based Budgeting?
Zero-based budgeting – which is also sometimes called a zero-sum budget – is a framework that forces you to account for every single dollar you have coming in, and how exactly you spend it. It also forces you to use all of your income so that, in essence, if you subtract your expenses from your income, it’ll equal zero.
At first glance, this may seem counterintuitive for someone who’s trying to save money, not spend it. But there are some important distinctions to spending your money in the way that zero-based budgeting dictates that you do.
First off, implementing this budgeting technique doesn’t mean that you’re free to go spend your money on whatever you want. Instead, it forces you to assign a specific intention or purpose to every dollar you spend, and this purpose has to somehow help you achieve your financial goals or improve your financial standing.
If you’re finding this concept a little tricky to grasp, think of it in terms of giving every dollar a specific job. After each dollar has a task to do, there shouldn’t be any money in your budget that hasn’t been accounted for. This makes zero-based budgeting somewhat distinct from the other types of budgets that we’ve covered in the past on our blog, like the:
With each of these types of budgets, the goal is to cut back on spending in order to free up your income. If you follow a zero-based budget template, your main aim is to simply shift what you ultimately spend your money on. In this way, it guides you to move away from frivolous spending and unnecessary shopping sprees to being more productive with your money. This could include things like paying down your personal line of credit, investing your money wisely, and contributing to your emergency savings fund.
What are the Benefits of Zero-Based Budgeting?
Before committing to zero-based budgeting, you’ll want to have some idea of how it might be able to help you. It can be useful for people who:
- Want to have greater control of how they spend their money
- Want to contribute more to their savings or retirement
- Want to cut out unnecessary expenses
- Want to work towards paying off debt, like their installment loan or personal line of credit
How to Create a Zero-Based Budget
The starting point of zero-based budgeting is similar to that of most other budgeting methods. The first thing you’ll need to do is thoroughly review your finances so that you can work towards putting together a budgeting system that fits your personal situation. Zero-based budgeting templates can definitely help you get started, but ultimately your budget should be fitted to your specifications. Having said that, we’re going to go over the essential steps you’ll need to go through in order to put together a zero-based budget.
1. Take Stock of Your Income
Like we mentioned earlier, you can’t start handing out jobs to your money without having a good idea of what your starting point is. Your income is what everything else in your budget is going to revolve around, so it’s important to give it your full attention.
To be clear, your total income can be made up of more than just the paycheck you get from your primary job. It can also include things like child support, any government programs you may get money from, or money you earn through a side hustle. So, make sure you’re accounting for all the money coming in and be sure to work with whatever you end up making after taxes (and any other deductions that might come into play).
2. Look at Your Expenses
Now it’s time to move onto your expenses. The goal here is to gain a better understanding of how you spend your money. This may be an easier task for some than others. While you might have a detailed mental catalogue of everything you spend money on, it would also be completely understandable if you didn’t.
If you fall into the second bucket, begin by going over your essential expenses. These may include things like:
- Rent or mortgage payments
- Transportation costs
- Utility bills
There are all sorts of other things that could go on this list, so make sure to include anything that’s specific to your situation.
Once you’ve accounted for these expenses, you can move on to the less essential things. And remember, zero-based budgeting requires you to account for ALL your spending. Every $2 bag of chips and occasional takeout order needs to be taken stock of, so make sure to be thorough.
3. Categorize Your Spending
Once you have a general list of all the things you spend money on, it’s time to start organizing them into specific categories. Again, you’ll need to specify these categories to your personal situation, but there are some general categories that some of your expenses will likely fall into. These can include things like:
Food: Groceries, coffee, takeout, delivery, etc.
Transportation: Gas, car insurance, subway fare, car repairs, etc.
Housing: Rent, mortgage payments, property taxes, home repairs, etc.
Media: Cable bill, streaming services, cell phone bill, internet, movie rentals, etc.
After you’ve sorted all your expenses into different categories, tally up how much you’ve spent in each area. Now that you have these numbers laid out before you, you can zoom out a bit and take a broad look at how you spend your money. This way, you can see if there are any glaring or easily identifiable problems with your financial output.
While there may be certain details about your spending that don’t come as a big shock, taking this type of view of your finances may reveal some surprises. For example, it might not be a big revelation to find that your rent or housing-related expenses are taking the biggest bite out of your budget. But you may be surprised to see how much you’re spending on all the streaming services you’re paying for. An added $10 a month here and there may not seem like much, but these expenses can start to add up. And do you really need Netflix, Crave, Disney+, AND Hulu to get your TV and movie fix? Getting these insights can help you make the decisions that come along later in the zero-based budgeting process.
4. Prioritize Your Categories
With your financial goals firmly fixed in your mind and your spending categories laid out before you, it’s time to start prioritizing your expenses. Basic needs that are essential to your survival should likely find themselves at the top of your list. You may also want to rank things like paying down debt and saving money high as well.
The things that end up at or near the top of your list should be what you need to survive as well as those that will help you achieve your financial goals. This is where your money should go before it trickles down to those categories that may be less essential (like entertainment for example).
5. Redistribute Your Money
With your categories in front of you and spending totals assigned to each one, now is the time to make adjustments where necessary. If we take our streaming services example from before, if you feel like the number of services you’re paying for is a little overkill, cancel one or two of your subscriptions to start with. Do you feel like your food category is a little too big? Try going out for lunch or dinner less often, or start to plan your grocery lists on what’s for sale that week.
The key is to be mindful and intentional with how you spend your money. If you make some cuts to certain categories and find you’ve opened up some room in your budget, redistribute this money to categories that will help you achieve your financial goals instead of blowing it on other forms of entertainment.
6. Get to Zero
If we go back to the very beginning of this article, you’ll remember that one of the main tenets of zero-based budgeting is to have your income minus expenses equal zero. By going through the previous steps and making tweaks to your budget, aim to achieve this.
If you find that your expenses are exceeding your income, you might need to revisit your categories and make some cuts. Or you may need to look for ways to boost your income.
If you’re in the opposite situation and you’re spending less than you’re earning, this is a good spot to be in, but one that still needs to be approached carefully. The potential issue here is that if you have extra money, it may not immediately have a job to do in your zero-based budget. And money without a task can quickly end up being money that’s spent on frivolous things. So, to make sure this doesn’t happen, assign it a job, like paying off your line of credit or contributing to a savings account.
Find a Budgeting System that Works for You
Budgeting and saving money, is not always the easiest task, and when you do manage to save a little extra cash, it can be tempting to reward yourself by spending it. If you’re worried about overspending and want to gain more control over your finances, zero-based budgeting may help you get there. It can be an effective way to spend with intention and cut out any bad spending habits you might have.
Ultimately, your goal should be to find a budgeting system that works best for you. This may take a little effort and research on your part, but in the end, it’s well worth it if it helps you to achieve financial stability!