What is Zero Based Budgeting?

By Sean Stevenson – Latest Revision February 15th, 2021

What is Exactly Is Zero Based Budgeting?

Zero Based Budgeting is a financial method where every dollar available from a monthly income is spent.  The purpose is typically to improve upon an existing fiscal circumstance. 

Specifically, the general idea is to apportion money towards expenses, debt payments, and investments.

This method can be used by both individuals and businesses.  In either case, a monthly income will be used in its entirety to fund various priorities.

In essence, under a zero based budget, your income will be matched by your expenditures.  This can be an effective way of getting the most out of every dollar you have available.

Example

Tom works as a waiter and makes good money from tips.  However, Tom’s real ambition is to build a drop-shipping business like the ones he has read about online.

To this end, Tom resolves himself to build a zero based budgeting system.  He will do so knowing that he can ultimately afford all of his expenses while putting the remainder of his monthly income toward building his drop-shipping business.

To this end, Tom budgets himself so that his monthly expenditures match his monthly income exactly. 

He is pleased with his initial results with zero based budgeting, and decides to write down his exact monthly finances for further reference:

Tom's Monthly Budget

 

Rent

$1,250

Clothing

$100

Credit Card Payments

$115

Student Loan

$200

Savings

$150

Car / Gas

$35

Insurance

$100

Entertainment

$85

Groceries

$215

Side-Business

$450

Total Expenditure

$2,700

Tom’s total monthly income is $2,700.  This matches his total monthly expenditure (depicted above) perfectly and would be an example of zero based budgeting.

Since Tom makes use of every single dollar in his monthly zero based budget, it not only allows him to pay his expenses, but also to develop his new business on the side.   

The defining characteristic of zero based budgeting is that it will always result in a monthly income being used in its entirety. 

Effective zero based budgeting takes into account how each dollar can be best utilized.  Not just for expenses, but also for investments that will pay future dividends.

Key Takeaways

  • Zero Based Budgeting is a financial method where every dollar available is spent.
  • The theory behind this method is built upon improving financial circumstances.
  • The best method of zero based budgeting revolves around using every dollar to its fullest -and most economically prudent- effect.

Who Should Use A Zero Based Budget?

A zero based budget can provide a great many advantages, depending on the situation. 

What is most important is that the individual or business considering a zero based budget understands its purpose.  It is to be used as a means of leveraging every single dollar available in a monthly budget.

This can be a great way of setting aside funds for investments, or ensuring that you stick to a financial plan.

Below are some of the distinctions of a zero based budget, as it pertains to both individuals and businesses:

For Individuals

A zero based budget can be a great way of ensuring you stay financially disciplined.

By setting aside each and every dollar for an exact purpose, you will be ensuring you don’t waste your money elsewhere on more frivolous pursuits.

Moreover, if you’re looking to invest, a zero based budget is a great way of allocating every dollar towards building your financial future.  It can also prove to be very useful in building equity within a home, by paying down a mortgage faster.

The key for any individual making use of a zero based budget is to ensure they plan their spending well in advance.

For Business

A business can make excellent use of a zero based budget, particularly if it finds itself in a growth phase.

A zero based budget can help a business use every dollar to create or improve upon its infrastructure.  Moreover, marketing campaigns, recruitment efforts, and even a workplace culture, can all thrive from the clever use of a zero based budgeting scheme.

The key for a business in making use of a zero based budget, is to allocate every dollar possible towards funding its primary needs. 

How To Start Your Own Zero Based Budget

There are a few steps involved before creating your own zero based budget.  Consider this a sort of “blueprint” or “plan” that will allow you to make the best fundamental decisions on how to proceed.

Start with the following:

Understand your income

This may sound obvious, but it often is not.  Many of us do not have a steady paycheck.  Even if you do, you will still have to make sure you account for every dollar available.  Try to gauge how you would ideally like to spend your money. 

Think of the best ways you can use each and every dollar to improve your existing circumstance.

Assess your priorities and expenses

Make a list of everything you need to budget for, down to the last dollar.  Decide which of these expenditures are most important, and number them from 1 to 10 (or more, depending on how many you have).  The top 5 should be your absolute “first priorities.” 

Try to make a mental note of how much money you’ll have to work with (approximately) after all your expenses are paid.  Then try to devise the exact amount you can allocate towards future investments, business ideas, or goals.

Categorize Your Finances

Here is a further list of priorities and other ideas that you will likely need to account for and categorize:

  • Your needs.
  • Your wants.
  • An emergency fund.
  • A travel fund.
  • A car fund.
  • A savings fund.
  • An investment fund.

Try to delve into all of these considerations and more.  Leave no stone unturned. 

Once you have a framework in place, you will then be able to address any weaknesses or shortcomings in your plan. 

Take your time and hash it out fully!  Rushing this process will lead to mistakes being made, which can prove costly.

PRO TIP:  Bear in mind, this list should be very accurate.  You must be able to reference it for later, in case you need further guidance (or if there’s something you missed).

Naturally, it should also cover every dollar you have available, for maximum effect.

Before Officially Starting Your Zero Based Budget

Take the time to track your income and expenditure for a few months.  If you have existing records, that can work as well. 

Gain insights into your habits and try to zero in on where you spend frivolously.  This will give you the wisdom needed to recognize what your financial strengths and weaknesses are.

For beginners, an ideal way of allocating a zero based budget is:

  1. First address your needs (50%).
  2. Second, address your wants (25%).
  3. Third, address your debt repayments, investments, and any additional savings (25% or remainder).
What is Zero Based Budgeting

As depicted above, you can budget for each requirement accordingly.  Remember, this process can be flexible to suit your needs.  Try to start slowly, and then improve over time!

Ideally, you’ll want to save and invest as much as possible.  However, you shouldn’t go overboard in doing so, as that can make you lose your motivation and discipline. 

Start your process gently.  Once you become more adept at saving, you can then start to up your contributions towards your investments and also budget for increased savings.

What is Zero Based Budgeting

In the depiction above, we can see a more seasoned zero based budget user.  Note the increase towards savings and investments.  Over time, this can lead to significant financial gains.  Incidentally, this is also how you can build a sizeable financial nest-egg.

Advantages and Disadvantages of Zero Based Budgeting

No budget is perfect.  There are always considerations to weigh.  Below are the advantages and disadvantages associated with zero based budgeting.

Advantages

  • Can be a great tool for people who struggle with financial discipline.
  • Will keep you acutely aware of where your money is going.
  • Can help keep you focused on financial goals.
  • Zero based budgeting is highly customizable, and can be tailored to suit different needs.

Disadvantages

  • A zero based budget requires careful planning, which takes time to implement.
  • It demands that you “zero-in” on monthly expenditures, which can be challenging for people who have little interest in reading their own spending habits.
  • Irregular expenses can disrupt your routine, forcing you to realign your goals with reality.
  • Requires separation of needs, wants, and investments, which takes a lot of discipline to adhere to over time.
  • Can prove ineffective for people who do not enjoy a regular income.

Zero Based Budgeting – Conclusion

Zero based budgeting offers a unique method of making effective use of every dollar.  However, it certainly isn’t for everyone.

Try sitting down and devising your own zero based budgeting solution.  Consider the time and money you could save if your plan worked well for you.

By tracking expenses and making prudent use of your own funds, you could soon be well on your way to implementing an effective zero based budgeting solution of your own.

Just remember to take it one step at a time!

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