Zero-based budgeting is one of the simplest forms of budgeting, in which you plan where your money will go before it comes into your account. Every last penny has a purpose, which is essential for rocking your personal finances. In the end, you should have a zero balance.
My first memory of zero-based budgeting was seeing my great uncle with his ledger. That ledger went everywhere he went. He was a carpenter and made kids’ toys to sell at markets. After all his scribbles, he would purchase more stock, stick some cash into an old rusty coffee tin, and finish the ledger off with a round zero. As a result, my great uncle always seemed to be on top of his finances!
While zero-based budgeting was a popular mode of budgeting for businesses in the 1970s, its recent revival is not just on the business front but also in personal finance. Here we outline how to use this method yourself. Also check out our other budgeting resources to get a clearer picture of budgeting in general.
How to set up a zero-based budget
Zero-based budgeting requires a bit of effort on your part. This budget style has slots for every type of expense, and every pound that comes in needs to be allocated to one of these slots. You add up all of your income, subtract all of your expenses, and allocate whatever is left over to a category such as savings, investments, home improvements, or whatever your needs are (note: not a shopping spree!).
Ending up with a zero at the end of the budget doesn’t mean there isn’t any money left; it simply means that the surplus money has been allocated to short-term savings or an emergency fund.
It’s vital to have a slot dedicated to ad-hoc expenses or emergency expenses for those months when the unexpected happens. If there is a deficit, however, it’s important to revisit each category to ensure that there is no overspending and that your lifestyle is affordable. Once all the bills are paid, there should be some money left to go towards savings and building up a reserve account.
Before setting up your budget, you may want to think about your financial goals and how you’ll meet them.
- Write down your financial goals – It’s important to know what you want out of your finances. You can then create your budget accordingly. This means creating the right categories. Be sure to include your needs, wants and obligations.
- Choose areas that need some extra attention – Remember to include high-interest debts and emergency savings. This creates room to allocate surplus funds.
- List all your income and expenses – It’s a lot easier to know where to put your money when you know your income and financial obligations. A surplus after you’ve allocated funds to all your obligations is great because it allows extra categories for your financial and personal goals.
Apps such as You Need A Budget (YNAB) and EveryDollar are famed for their zero-based budgeting approach but are only available in the USA and Canada for now. Brits can make use of a spreadsheet, and a number of options are available online.
Here is an example of what a zero-based budget may look like:
Possible benefits of zero-based budgeting
Your spending decisions will improve
Once every penny has a function, it’s hard to lose track of your spending. Categorising your spending can offer new insight into where your money goes and whether it serves you. That extra tenner in your wallet now has a purpose for something in your budget. If you didn’t categorise all your money into various slots, that same tenner might easily go towards snacks and knick-knacks you don’t really need.
You may also be able to eliminate some duplicated costs. Subscription services, for instance, have overlapping programming schedules with digital television. For many people, one service will suffice. Other such costs may include telephone and mobile phone costs.
You’ll taste financial freedom through financial control
Zero-based budgeting was so successful in the 1970s because it created pockets for each financial discipline. Households were able to control their expenses, meaning they could invest in the future. They could also allocate funds knowingly into paying off loans. The extra control ensured that no money was trickling into areas that didn’t serve the household. Every pound spent should serve a personal budget, and with the extra control, it’s far easier to reach financial goals.