Zero based budgeting (ZBB) refers to a method of budgeting where all the expenses need to be justified for every new period. It starts from a ‘zero base’, and then every function within the company (or the family) is analyzed for the needs and costs. Then, the team sets a budget around the needs of the company for the following period. This step is done regardless if the budget is higher or lower than the one made for the previous period. Today we are going to see how to set up a zero based budget step by step.
How to Set Up a Zero Based Budget
1. Write Down the Monthly Income
The first thing you need to do if you want to know how to set up a zero based budget is to write down the income every month. You can do it with a sheet of paper, use a chart on your computer or an app. Regardless of the way in which you decide to do it, you need to include the following:
- Side sources;
- Small-business income;
- Residual income;
- Child support (for a personal zero based budget), etc.
Make sure you write all the sources of income down and add them up at the end.
2. Write Down the Monthly Expenses
Next, you will need to write down the expenses you have before the beginning of the new month (or another period you want to set). Start with the basic needs and then add to it. For example, you need to put down things such as rent, phones, utilities, transportation, etc. Then, you need to see what other things you spend money on: equipment, repairs, occasional expenses, etc. Obviously, some needs change from month to month, which is why you need to renew the spending plan accordingly.
3. Check Seasonal Expenses
An important part of setting up a zero based budget is to think about the whole calendar year. What expenses do you foresee? For example, if the next month is December, you know there will be some expenses with presents, parties, etc., even if they’re personal or professional. Similarly, there are also some periodical taxes or fees you will need to consider.
4. Make a List of Savings and Debt Reduction Goals
Include on this list anything that’s not a required payment or a savings contribution. Some examples are things that you want and afford to do, such as:
- Education savings;
- Vacation savings;
- Retirement savings;
- Emergency fund savings;
- Extra payments for credit cards and loans, etc.
5. Subtract Expenses from Income
As we previously explained, the goal of the zero based budget is to make a spending plan where the total income minus the monthly expenses equal zero. If you try to do this and you obtain a negative number, you might need to cut down on your expenses. A good first step would be to cut out the things that aren’t essential, such as entertainment. If the number stays negative, it’s time to see if you can decrease any payments, at least temporarily.
If the result is a positive number, you need to increase the ‘expenses’. For example, instead of buying something new on credit, you can increase the savings or debt reduction goals until you reach zero.
6. Track the Changes
Now, all you need to do is to track the expenses for the month or the period you wish to monitor. This is the only way in which you can make sure that your spending follows the plan. It’s a way in which you can start winning money both throughout a month and throughout a year. Whenever you track your expenses and actively engage with your money, you will make significant progress. And your bank account will love it.
As perfect as the plan may sound, there are still some possible issues that might appear. The following two are the most common:
- You spend more than the allocated targets in one or more categories;
- You spend less than the allocated targets.
But why does this happen? Remember that a budget is merely a rough prediction. Compare it to the rough draft of an essay. You need to return to it and refine any errors you previously made at the end of the month. Don’t be afraid to analyze your previous mistakes, since they will influence your method as you come up with other budgets later.
Besides the issues above, there are some red flags you should pay attention to:
- You consistently spend more than the target in certain categories.
In this case, the solution would be to increase the allocated funds for that certain category, but only if you are within the recommended ranges. In case you are exceeding the recommended ranges, it’s better to cut down on the spending.
- The spending exceeds the income.
For this, the solution is a simple one: just stop spending. Every time you take out your wallet or your card, think whether it’s worth it or not. Try not to eat so much in the restaurants, stop buying new items if you don’t really need them. Cutting down on transportation is yet another good idea. Alternatively, there is yet another perspective: try to find new sources of income to support your expenses. This can supplement the amount you have on your hands, but this means you will have to redesign the budget entirely.
The zero based budget is a great tool if you want to gain a better understanding of your money. It takes only a couple of minutes to assemble it, but the rewards are amazing. What’s important is not to panic if you notice you’ve made mistakes either in designing the budget or in applying it. Write them down, see what didn’t work out and adjust the next budget accordingly. Most people don’t get it right the first time, so you don’t need to worry about that. However, if you notice some serious red flags, like the ones we presented above, you should start questioning your spending decisions.
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