A written budget is one of the best tools for managing money. Zero-based budgeting, or ZBB, takes a written budget to the next level by assigning every dollar a job to do. This approach prevents overspending and encourages savings. That means more money in your pocket. Cha-ching!
What exactly is a zero-based budget? Find out next.
What is a Zero-Based Budget?
A zero-based budget is a budget method for managing money. Under this method, income minus expenses equals zero, inspiring its name.
Because income equals expenses, every dollar of your income is assigned a job. Keeping money in your bank account.
And that’s fire.
Because your money works hard to help you meet your savings and spending goals.
So, if you earn $3,000 in monthly income, your monthly expenses would also be $3,000. Creating a difference of zero. Income minus expenses is zero.
Because expenses aren’t greater than income, this method is also effective in curbing spending and preventing debt.
Why is Zero-Based Budgeting Important?
Using zero-based budgeting is important. Here are a few reasons why.
- Increases financial awareness – Helps individuals and families know where their money is going and track how much they have received.
- Controls expenses – Prevents overspending by allocating money to various cost categories such as eating out, travel, and gas etc.
- Achieves Financial Goals – Enables financial goal achievement, whether the goal is to save money, reduce spending, or pay off debt
- Promotes emergency preparedness – Can include a savings plan for an emergency fund
- Encourages peace of mind – Reduces stress related to finances while encouraging confidence in money management
- Helps decision-making – Having a budget provides a picture of how resources are being spent. If money needs to be reallocated because of an emergency or a change in priority, it will be much easier to do so with a budget in place.
Now that you know what a zero-based budget is and why it’s important, let’s explore how to make one.
How to Make a Zero-Based Budget in 4 Steps
Set Your Budget Period
A budget period is the timeframe that your budget will cover. A few example periods include:
- Weekly
- Bi-Weekly, and
- Monthly
If you’re new to budgeting or your income varies a lot, you may want to choose a shorter budget period, such as weekly or bi-weekly. However, a monthly period may be more suitable if you have budgeted before or your income is more predictable.
Another consideration when choosing a period is how often you want to prepare a budget. If you don’t have much time, you may opt for a monthly budget period because it will need to be prepared less frequently. Or, you may prefer shorter periods if you have more time.
Next, you will estimate your income for the budget period.
Estimate Income
Income represents how much money you receive. You can receive money from a variety of sources. Some of those sources include:
- A job
- Sale of goods, or
- Gifts
You’ll want to add up all your income sources to estimate the month’s income.
If you have an hourly job, your income may vary depending on how many hours you work. You can use a three- or six-month average of your take-home pay as a baseline for the month. Take-home pay is the amount your employer deposits in your bank account. It’s also known as net pay because it’s your gross pay minus deductions and taxes.
Now that you’ve estimated income let’s look at expenses.
Estimate Expenses
Let’s say you picked a month as your budget period. You will want to estimate all your expenses related to the next month.
When brainstorming expenses, it is helpful to think in expense categories. One easy set of categories you could consider is savings, needs, and wants. Here’s what each represents:
- Savings – This is where you set money aside for emergencies and future use.
- Needs – These are required costs or money you must spend. It covers areas like: school lunches, car insurance, cell phone bill, gas, and credit card payments (if you have any)
- Wants – These are optional costs, things you want to purchase but don’t need. They include travel, clothing, eating out, and fun.
Now that you have your categories, you can think of the individual expenses that would be in each area. After you have listed your expenses you will need to add the expected costs. For recurring expenses, you can you past spending history. For new costs, use your best guess.
Lastly, you will add one more expense category called, Reserve. This is a buffer in your budget to account for unplanned costs, omitted expenses, and conservative estimation. Add a cost you’re comfortable with to the Reserve and you’ve completed estimating your expenses.
Now, you’ll verify your work.
Check Your Budget
Lastly, you will want to verify that income minus expenses is zero.
If the result is positive, meaning you have income left over,
- Check to make sure you’ve included all your expenses
- Consider increasing your Savings or Reserve amount
If the result is negative, meaning you’ve overspent, you will need to reduce your spending to bring the difference to zero. You can focus on making reductions in any of the following categories:
- Wants,
- Reserve, and
- Saving.
With an example, let’s see the 4 steps to create a ZBB in action.
Example of a Zero-Based Budget
John, a high schooler, wants to make a Zero-Based Budget. This is his first time making a budget, so he picks a budget period of a week. He earns a take-home pay of $180 from his job at Starbucks. After some brainstorming, he comes up with the following list of expected expenses for the week:
- Savings
- Emergency fund $20
- Need
- Car insurance $50
- Gas $30
- Cell phone $30
- School lunches $20
- Want
- Extracurricular activities $10
- Graduation photos $10
- Reserve $10
John wants to check that this budget difference is zero. He inputs his income and expenses into a budget template and verifies that income equals expenses.
You can now follow the same steps as John. Customize the above budget template to reflect your budget data.
Conclusion
Zero-based budgeting is a tool for managing money. By making expenses equal to income, every dollar works hard to help you meet your financial goals. To make a ZBB, all it takes is four easy steps. Begin with step one, setting your budget period, today.
Contributor