Zero-based budgeting (ZBB) is a budgeting method in which all expenses must be justified for each new period. This means that all expenses must be approved and budgeted for each period, rather than simply using the prior period’s budget as a starting point. This method requires a detailed analysis of all expenses, and is often used by individuals to control their personal finances and ensure that their money is allocated efficiently.
How zero-based budgeting (ZBB) works
In zero-based budgeting, all expenses are evaluated from scratch for each budget period. This means that each category of expenses must be justified, including those that were incurred in the previous period. This process typically starts with a review of the current budget, and then an analysis of all expenses to identify areas where costs can be reduced or eliminated. Once this process is completed, a new budget is created based on the justified expenses.
Zero-based budgeting example
For example, an individual may have a budget for entertainment expenses of $500 for the previous period. Under zero-based budgeting, the individual would be required to justify each expense in the budget, including the cost of going to the movies, buying concert tickets, and dining out. The individual may discover that some expenses are no longer necessary, and may be able to reduce the budget to $400.
How to start a zero-based budget
Creating a zero-based budget can be a little more time-consuming than traditional budgeting, but it can be a powerful tool for managing your money and achieving your financial goals. Here’s a step-by-step guide to creating a zero-based budget:
- Gather your financial information: The first step in creating a zero-based budget is to gather all of your financial information. This includes your income, expenses, and any savings or investments you have.
- Create a list of your fixed expenses: Fixed expenses are those that are the same amount each month, such as rent or mortgage payments, insurance, and car payments. Make a list of all of your fixed expenses and their amounts.
- Create a list of your variable expenses: Variable expenses are those that change from month to month, such as food, entertainment, and clothing. Make a list of all of your variable expenses and their average amounts.
- Review your expenses: This is where you need to “justify” your expenses. Look for areas where you can reduce or eliminate costs. For example, you may be able to cut back on dining out or entertainment expenses.
- Set your financial goals: Before creating your budget, it’s important to set your financial goals. Identify what you want to achieve financially in the short-term and long-term. Whether it’s paying off debt, saving for a down payment on a house, or building an emergency fund, having specific goals in mind will help you make better budgeting decisions.
- Allocate your income: Once you’ve reviewed your expenses and set your financial goals, it’s time to allocate your income. Start by paying yourself first – set aside a portion of your income for savings and investment. Then, allocate the remaining income to cover your fixed and variable expenses.
- Track your spending: After creating your zero-based budget, it’s important to track your spending to make sure you are staying on budget. Use tools like budgeting apps, spreadsheets or a simple pen and paper to track your expenses.
- Review and adjust: Review your budget regularly, at least once a month. If you find that you are consistently overspending in certain areas, make adjustments to your budget to bring your spending back in line with your income.
Remember that creating a zero-based budget requires time and effort, but the benefits are well worth it. With a zero-based budget, you’ll have a clear understanding of where your money is going, and you’ll be able to make better-informed decisions about how to allocate your resources to achieve your financial goals.
Advantages of zero-based budgeting
- It forces you to justify all expenses, which can help you identify areas where you can reduce or eliminate costs.
- It helps you to prioritize your spending, so that you can allocate your resources more efficiently.
- It can help you to identify areas where you may be overspending, and take steps to correct this.
Drawbacks of zero-based budgeting
- It can be time-consuming to create and maintain a zero-based budget.
- It may be difficult to justify certain expenses, which can lead to frustration or resistance from yourself.
- It may be difficult to implement in some cases, as it requires a significant change in budgeting processes and habits.
Zero-Based budgeting vs. traditional budgeting
Traditional budgeting is a budgeting method in which a budget is set based on the prior period’s budget and incremental changes are made to it. In contrast, zero-based budgeting starts from scratch and all expenses must be justified for each new period. Zero-based budgeting is more time-consuming and requires more detailed analysis of expenses, but it can help to control costs and ensure that resources are allocated efficiently in personal finance.
Other popular budget methods
- Envelope budgeting: This method involves using physical envelopes to allocate cash for different expenses. Each envelope is labeled with a different expense category, such as groceries, entertainment, or gas, and cash is physically placed in the appropriate envelope as income is received. When the cash in an envelope is gone, no more can be spent on that category until more income is received.
- 50/30/20 budgeting: This method involves dividing your income into three categories: 50% for needs, 30% for wants, and 20% for savings.
- 70/20/10 budgeting: This is another popular budgeting method that involves dividing your income into three categories: 70% everyday expenses, 20% for savings, and 10% for debt repayment and donating.
- Reverse budgeting: This method involves paying bills and savings first, and then allocating the remaining money for discretionary spending.
- Pay yourself first: This method involves putting aside a certain amount of money for savings and investments before allocating money for other expenses.
- The cash diet: This method involves using cash only for expenses and tracking cash flow, it can help people understand their spending habits and make them more conscious of their spending.
- The Value-Based budgeting: This method involves allocating money based on the value that a particular expense or category holds for the individual. It prioritizes spending on the things that are most important to the individual and cutting back on less important expenses.
- The Debt Snowball method: This method is focused on paying off debt, it starts by paying the smallest debt first and then moving on to the larger ones. As debts are paid off, more money becomes available to put towards paying off the next debt, creating a snowball effect.