You may have heard the recent buzz about zero-based budgeting as a way to transform your personal or business finances. If you find yourself strapped for cash, unable to save, or paying off debts slower than you’d like, you may want to consider implementing a zero-based budget.
The concept of a zero-based budget originated with Pete Pyhrr in the 1960s. By the 1970s, his strategy reached the front gates of the White House. Today, Fortune 500 companies and private equity companies have also adopted this innovative budgeting model.
If managing your money feels overwhelming, you’re not alone. However, finding new, smarter ways to manage your money doesn’t have to be a lofty, far-off goal. As money budgeting apps become more readily available, users want to feel in control of their finances. Zero-based budgeting helps you manage your money today so that your long-term savings goals feel within reach.
What Is a Zero-Based Budget?
What exactly is a zero-based budget and what are its inherent benefits? Zero-based budgeting is based on the idea that people are best able to manage their money when they can account for every dollar saved or spent. Each month, a person or business allocates 100 percent of their income toward expenses, savings, and debt payments. As earnings increase, you can place more money into savings or roll the surplus into next month’s income, especially if you anticipate irregular spending (e.g., for traveling or medical expenses).
Think of each category as a “digital envelope” in which you set aside exactly the funds you need for each area of spending and no more. Begin to track the money you spend on things like food, rent or mortgage, transportation, and entertainment as a barometer for tracking future spending.
At the end of the month, your budget should mirror the following formula:
Income - expenditures = $0 each month
To kick-start a zero-based budget of your own, you’ll need to be aware of your current spending and savings habits. Using a tool like MoneyTrack, you’ll know exactly how much money is coming in and going out each month. This will help you determine your spending categories.
Zero-based budgeting offers flexibility. You can redefine spending categories each month as your expenses and savings goals shift over time. The more specific you can be about each category, the better you can budget over the long term. If you come in under budget, either set the money aside for next month or put additional money toward your savings.
Benefits of a Zero-Based Budget
At its core, zero-based budgeting holds you accountable for the money you spend. After just a few months using this model, you’ll be able to identify where you’re overspending and where you are saving more, and you may even find opportunity for bigger changes such as boosting your monthly income and paying down debt. By conducting a cost-benefit analysis, you’ll be able to lower costs and allocate surplus earnings toward next month’s budget. Because every dollar gets allocated, this is also an exercise in justifying every expense and engaging in active rather than passive saving and spending.
Budget bloat occurs when your monthly spending is much higher than your monthly earnings. Of course, over time, this is unsustainable. A zero-based budget helps you detect an inflated budget more quickly.
Most people find new budgeting processes to be cumbersome. However, zero-based budgeting allows you to automate online spending and billpay so you can avoid unnecessary fees and overdraft charges in the process of building better spending habits.
Understanding the Challenges
Although the advantages are clear, people who adopt a zero-based budget should be aware of some potential pitfalls. Just like setting up any new budget, zero-based budgeting can take some time to implement. You’ll need to assess your finances first and be willing to adjust your budget as your earnings, savings, and expenses fluctuate.
For companies, it may take some time to convince all departments to get on board. Some of your employees have likely heard of zero-based budgeting, but some will be unfamiliar with the concept. Also, the metrics used to quantify zero-based budgeting differ from those used in traditional budgeting strategies. All employees must have a clear understanding of how categories will break down and which departments are responsible for allocating specific funds. Once employees know their roles and begin to witness the benefits of zero-based budgeting firsthand, they’re more likely to buy in over time.
If you’re looking to manage a budget of your own but are unsure where to begin, FSCB has the resources you need to get started. Check out our free e-book, A Complete Guide to Budgeting, to learn more.