What Is Zero-based Budgeting and How Does It Work?

zero based budgeting
September 9, 2020 by Stuart Smale

One of the best ways to make sure that you don’t have significant financial issues is to use a zero-based budget. This strategy can help you stay within your means and at the same time plan for future financial security.

So, what is zero-based budgeting and how can you ensure that it works for you?

What Is a Zero-based Budget?

A zero-based budget is when you develop a financial plan for the month that accounts for every single penny before it’s spent. Whatever you earn and have incoming has a particular expenditure or use assigned to it.

The idea of the plan is that with a zero-based budget, you know exactly where the money is going and that you don’t worry about the amount of certain costs. This puts you in control of your financial spending and you can assess purchases and needs more closely, ensuring that you don’t get into financial difficulty again.

The Benefits of Zero-based Budgeting

The obvious benefit of zero-based budgeting is that you’re running your personal finance based on your actual income. Therefore, you can build a financial lifestyle that allows you to have all the essentials plus some luxuries well within your means. You don’t overspend, nor do you scrimp when there is no need to.

Another benefit of zero-based budgeting is that it allows you to allocate money towards saving funds and investments that can help you when times are tough.

Finally, zero-based budgeting allows you to lose the panic when there are large expenses. A classic example would be rent or mortgages. These can be some of the biggest expenses you have in a month and people can sometimes panic when they see those expenses leave their account. However, if you know there’s some more money in the account that’s allocated for food and other items, then you won’t worry so much.

What Tools Do You Need for Zero-based Budgeting?

The best thing about zero-based budgeting is that you can use any tool you want to get it right. The old-fashioned pen, paper and calculator might be your style or you could use a spreadsheet on a computer or a mobile app.

Whatever tool you use, you must be comfortable in using it.

How to Start With Zero-based Budgeting

Step 1 – Your income

When it comes to starting with zero-based budgeting, you need to know what money you’re getting in. You should start with the amount of income you get. This should include all income from employed work, business income, side hustles, benefits and anything else that pays into your account.

When you’ve written down all the income that comes into your home, then you need to add it up. This is the total amount of your income and it’s exactly what your expenditure total should also be.

Step 2 – Monthly expenses

Next you need to write down all the expenses that you expect for the month. This should be everything from your rent/mortgage, food, TV, phones, other utilities, insurance to any subscriptions you pay out for. You can use previous bank statements to work out what your regular monthly expenses are.

You should add other expenses that might change from month-to-month next. You should know the exact amount for these expenses. These changeable expenses are one of the main reasons why you need to make a new budget every single month.

Step 3 – Miscellaneous expenses

You should also add a section that is labelled miscellaneous expenses. This is the catch all segment that allows you to spend money on things that suddenly turn up after the budget has been completed. This can include things like one of your children’s friends having a birthday party. Or, you could have a white goods item that needs replacement or repair.

If this money isn’t spent at the end of month, don’t go and spend it on something luxurious. Instead, go and put it away. Next month you could have a larger unexpected cost.

Step 4 – Savings

Remember to always have a category for savings in your budget. This can be savings for a holiday, car, home deposit or just for retirement. It’s important to have a savings element because if you don’t add one in, then you’ll never save any money.

Step 5 – Seasonal expenses

Now you can add seasonal expenses to your budget. This is when you take the costs for Christmas and divide that for the entire year. This money could be spent, like buying a present for someone when you see them, or saved for a spending trip closer to a holiday.

Including some seasonal expenses like this means you don’t overwhelm your budget later on. You should also think of expenses like TV licenses, car tax and other annual/irregular payments.

Step 6 – Subtract expenses from income

Now you take the total of all your expenses and subtract that figure from your income. We want that number to be zero. But it might take some fiddling with the numbers to get there. For instance, you might have more money than you thought. So you could add some money onto your food costs or into your savings.

Or you could be short and you need to take some money off luxuries like outings or the holiday fund.

Most people find it a struggle to manage the zero-based budget on the first take. In fact, it can take three to six months before someone actually manages to balance the budget so that it comes to zero.

The important thing to remember is that you need to stick to that budget. If you budget £600 for food in a month, divide that between the number of weeks, or even days, and stick to that amount. Don’t be tempted to spend a bit more this week to save next week, it rarely happens unless you’re very disciplined.

This is where an app or spreadsheet can come in handy because the small changes can show instant results on the end figure.

Step 7 – Repeat

Remember to repeat this every month. Don’t get lazy and use the previous month’s budget, the budget should be done on a monthly basis. Incomes and expenses can change in an instance, so you need to be prepared.

Conclusion

Zero-based budgeting is a great way for you to manage your personal finance. However, it requires a disciplined mind. It needs to be done every month but in the end, it can help you take control of your finances and start planning for the future.

Is the managing director of Cobra Payday Loans and Ready Money Capital Limited. He is responsible for all the day to day functions and performance of both companies and regularly contributes information on the short term finance sector. Stuart is an approved person with the Financial Conduct Authority, holding SMF3 (Executive Director) status.

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