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How to Build a Zero-based Budget

A zero based budget is a budget where every dollar you earn is assigned to a category in your budget. Your income minus your expenses equals zero – zero based budget. The idea sounds very simple, and it is, but the real value in creating and following a zero-based budget is that it requires you to plan very deliberately ahead of time and track it very closely as you go through your month.

Benefits of Zero Based Budgets

The main benefit of creating a zero based budget is in the creation process. By forcing you to assign a dollar of income to each expense, you are taking a look at the entirety of your finances. You are forced to remember and allocate dollars to otherwise automatic expenses – such as rent, car insurance, and cable television. As you go through the budgeting process, you might consider shopping those services around to see if you can get them for less so you can spend that money on another expense.

Another big benefit is that by assigning each dollar of income to a category in your budget, you move away from a mindset of casual spending to one of deliberate spending. Unlike envelope budgeting [3], where you have some wiggle room, you take that wiggle room away when you zero base your budget because there’s no miscellaneous envelope.

Creating a Zero Based Budget

  1. List your sources of income. Your budget starts with a list of your household income – paychecks, bank interest, investment dividends, etc.
  2. List your expenses. This step is probably going to be your hardest because you have to remember all the expenses you pay for each month. Remember expenses that might be paid on a quarterly, semi-annual or annual basis like insurance. Break out aggregate payments like your mortgage – principal, interest, taxes, insurance. Then add a savings expense (or one savings expense for each savings goal you have) and a discretionary category (separate this from an entertainment). As you use the budget, add to this list so that it captures each expense you have.
  3. Allocate income to fixed expenses. Fixed expenses are those that you can’t change easily – like your mortgage payment or cable bill. You can change them if you wanted to (refinance or sell your house, change cable plans) but they’re not like a “restaurant” category that you can chance very easily.
  4. Try to make adjustments to fixed expenses. If you wanted to shop around for cable television or your insurance policy, I recommend doing that so you can distribute more of your income to more fluid categories. You may even decide to cut some of these fixed expenses, like a magazine subscription or Netflix.
  5. Start allocating to fluid expenses based on history. If you’ve never kept a budget, make an educated guess. If you have, use what you think is a reasonable amount.
  6. Zero your budget. At this point, if your income doesn’t equal your expenses, start playing around with it until it does. Add more to savings or discretionary balances (it never hurts to be ahead of schedule on savings!) or some other fluid category.
  7. Stick to your budget. Now, as you go about your month, track your spending an stick to your budget. It’s difficult to go from no budget to zero based budgeting but if you can stick with it, it will pay dividends down the road.
  8. Adjusting your budget. Each month, as you have your spending data, adjust your categories to fit your actual use and adjust your actual use to fit your budget. 🙂 Somewhere in the middle is where you will need to be, so constant adjustment is important. Also, if you have extra slack in your budget (ie. you have $1000 in income and despite having it all budgeted out, you spent $990), take the slack and add it to your discretionary or savings category. If you’re under (spent more than your budget), you have to take a look at your categories, which you’ve now neatly laid out, and find areas to make some cuts.

As you can see, zero based budgeting is very deliberate but not unlike many other budgeting methods [4]. It’s also a budgeting methodology that requires very little in the way of tools. While you could turn to a budgeting tool [5] to help you out, the hard work is in the planning and adjustment of your zero based budget. All that can be done, fairly easily, using Microsoft Excel or some other spreadsheet application.

(Photo: thetruthabout [6])