Zero Based BudgetingDec 28, 2020
Creating budgets and cutting costs are two activities that we may not find exciting but are some of the important activities that aid in optimising the health of our finances.
To stay on top of your personal expenses, you need to create a budget and constantly update it to reflect a true picture of your circumstances.
While you’ll create a new budget by tweaking a previous one when using a traditional budget, a more effective way that produces better results is zero-based budgeting.
In this article, you’ll learn all about zero-based budgeting, how it compares to traditional budgeting, how to create one and much more. So let’s get started!
What Is Zero-Based Budgeting?
Zero-based budgeting is a unique budgeting method where the total income and expenses are reviewed as a new budgeting period.
It is not based on the previous month's budget and therefore, no monies should be carried over to the next.
It is a form of budgeting where income minus your expenses equal zero.
For example, let’s say you earn £2000, everything you spend, save, or invest should add up to £2000.
The zero-based budget ensures your expenses match your income throughout the month, so you can be sure every penny is being put to use the right way.
The zero-based budget allows for only the current expenses and income to be planned for at that specific time.
Who Introduced Zero Based Budgeting?
Zero-based budgeting was developed by Peter Pyhrr while he was an accounting manager at Texas Instruments in the 1960s.
He created zero-based budgeting as a way of incorporating top-level strategic objectives into the state budgeting process by ensuring they are tied to specific functional areas in the organisation.
Zero Based Budgeting vs Traditional Budgeting
Where traditional budgets only capture what has been spent in a given month, a zero-based budget ends with a zero and seeks to justify old, recurring expenses as well as new expenditures.
Advantages And Disadvantages of Zero Based Budgeting
Advantages of Zero Based Budgeting
1. It keeps you abreast of cash flows
With a zero-based budget, you can tell how much money goes in and out of your accounts monthly. This prevents you from buying things on credit and since you are tracking your cash flow, you can get into a better place of financial security.
2. You can customise the budget to fit your specific needs
If you are just beginning to manage your personal finances and have to meet specific needs monthly, then you’ll be able to effectively determine which items to add or subtract to your monthly budget.
3. It looks at the reasons why you are spending money
Traditional budgeting processes look at how much you spend whenever an expense is made. While the zero-based budgeting method also considers this, it takes into account the reasons why you are making spending decisions. It looks at the choices you make, helping to steer you toward specific objectives. Zero-based budget corrects any spending behaviours that negatively impact your financial health.
4. It quickly detects overspending
If a specific line item in your budget takes a bulk sum of the money, then zero-based budgeting will detect the issue quickly. It looks at the exact amount needed within a review period with the expectation you will run out of money there. When there is a remaining balance there, this shows then helps you to decide the other areas of your finances you could allocate this money to.
5. Zero-based budgeting creates a need to justify each expenditure
You can better make choices about your spending habits with zero-based budgeting regardless of whether the things you buy are needs or wants. You have to have a specific reason for making the purchase you make. If you can come up with a valid justification for pursuing something, this approach suggests that cash flows should be maintained.
Disadvantages of Zero Based Budgeting
1. It takes a lot of time to manage a zero-based budget
To hold yourself accountable to your zero-based budget, you have to closely monitor your spending month by month. Creating this structure can be a challenge if you are new to budgeting. Irregular expenses need to be accounted for and tracked monthly. To avoid this, create more time and be patient.
2. This budgeting method can be difficult on an unpredictable income
The zero-based budgeting works best with a predictable monthly income level. It will be difficult to know how much to allocate money monthly if you are a freelancer or an independent contractor, not that it is impossible to implement zero-based budgeting with this income. To be able to use zero-based budgeting on a variable income, you would need to regularly update and review your monthly budget as and when income comes in.
3. Promotes Perfectionism
With a zero-based budget, it’s easy to fall prey to budgeting perfectionism. You could be setting yourself up for anxiety, and increased financial stress, which counters the reason for budgeting in the first place. With this, don’t go too hard on yourself but be flexible enough to know that you may not hit the perfect numbers every month, but can learn from it and refine your budget for the following month.
How To Create a Zero-Based Budget
1. Write down your monthly income
You can use the old fashioned paper writing style, excel spreadsheet, or with a budgeting app.
2. Write down your monthly expenses
Do this before the beginning of a new month. Start your budget with the basic needs, which include essential expenses such as shelter, food, utilities, insurance and transport to work. Having covered these important things, you can add a miscellaneous category.
3. Write down your seasonal expenses
Take a look at the whole year, and allocate a monthly savings amount for events like Christmas, birthdays, or anniversaries. Include these expenses within your budget. Many irregular expenses like car-renewal fees, property taxes and more can pop up periodically, and should also be budgeted for. Be sure to include debt repayment and investments.
4. Subtract your income from your expenses to equal zero
Even though you want this number to be zero, don’t be surprised if your income and expenses don’t balance out initially. at the moment. This only means you should do something to get one of the numbers up, and bring the other down, or to do both (income up or expenses down)! While it may take you some time to work with a zero-based budget, it’s important to be patient with yourself and stay consistent with this budgeting method for you to see the true benefits.
5. Track your spending throughout the month
What’s left now is to begin tracking your monthly expenses. This way you’ll be able to tell if your spending lines up with your plan. By intentionally tracking your expenses, you can see what progress you are making with your goals.
It's a wrap
Whether you are trying to get out of debt, putting money away for short term goals business, or saving up a safety net, You’ll need a budget, and implementing a zero-based budget means you are taking a realistic approach to spending, helping to see what your money is being used for, and not having to scramble to make up for surprise expenses.
It also ensures you don’t live a paycheck to paycheck income dependency lifestyle since the zero-based budget allows you to cover all your bills and monthly expenses without overshooting the budget.
If you are ready to take the leap and make a change to your financial life, then you should consider getting started with zero-based budgeting.