Building a Zero-based Budget

The best way to save money is by creating a budget plan and sticking to it. Today we will look at zero based budgeting. A zero based budget is a budget where every dollar you make is assigned to a certain category. In other words your income minus your expenses should equal zero.

A great benefit of creating a zero-based budget is that you are forced to look current state of your finances, because you have to assign each dollar of income to a category. Although sticking to the routine can be hard the first few months, if you stick with it you’ll notice that your mindset will change over time, from casual spending to one of deliberate spending.

Three Category Types

Before we start you need to know the category types and the differences between them:
Fixed categories – payments that you have to make or can’t easily be changed. For example a mortgage payment.
Static categories – payments that look fixed, but you can change them, for instance by canceling them. For example Netflix or golf course membership.
Variable or Fluid categories – payments that can be different each month. For example entertainment.

Creating a Zero Based Budget

1. Start by listing ALL your source of income. This means that you need to list all of your household income and not only a paycheck, also investment dividends, bank interest, etc.

2. The next step is listing all your expenses. Usually this is the hardest step, because you need to find all the expenses you pay each month. And this can be a real eye opener!

Also you have to remember that some expenses aren’t paid monthly, but also quarterly, semi-annual or on annual basis. Make a category in your budget for quarterly and annual payments and break the amount into monthly payments. This way you put money aside (open a separate saving account for this money) each month, until it’s time to pay the quarterly or annual bill.

Make a category for all your expenses (mortgage, taxes, insurance, retirement fund, car payments, clothing, household, entertainment, savings and so on.) Make sure you find them all, but don’t make the category’s to general. With this I mean that you don’t put everything little thing under the same category, example groceries will fall under the household category, but clothing should not fall under household. Also the opposed is true, you don’t want to have for example 100 separate categories. Your categories should be balanced.

3 take a look at the site here. The next step is to allocate income for all your fixed expenses. Fixed expenses are those payments that you have to make or can’t change for example mortgage payments.

A gym membership is not a fixed expense, because you can cancel the membership and train in the park! See the difference? These expenses will fall in your static categories.

4. Try to make adjustments to fixed or static expenses. This way you’ll have more money for your fluid categories. For example you make fixed payment for your families insurance, maybe you can get a better deal somewhere else.

I know, I know, changing your insurance will take time, so you can’t adjust it right away. You don’t have to do this right away, you can create your budget first (by making the adjustment that you can do now) and after you have made the adjustment you change your zero based budget.

Another thing, you don’t have to cancel everything, if you have enough income. But if you cancel things because you have to then make sure that you also need certain things for the quality of life. With this I mean the following: if you really like your gym membership then try to find something else you can cancel.

5. Start allocating to fluid expenses. This can be a hard one, so make an educated guess if you have to. Use what you think is a reasonable amount.

6. Zero your budget. Now that you have all you income, expense and categories start playing around until each dollar is assigned to a category. Add more money to savings or discretionary balances or some other category. (If I where you, I would put additional money in the saving category or retirement fund.)

7. Now the hard part, sticking to your budget. Track all your spending during the next month and stick to your budget. At can be hard in the beginning, but if you stick with it, it will become easier each month and it will pay dividends down the road.

At the end of each month you can make minor adjustments, but you have to make sure you reach zero.

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2 Responses to “Building a Zero-based Budget”

  1. Why We Like Zero-Based Budgets on December 26th, 2010 20:10

    […] Building a Zero-Based Budget […]

  2. Cad on August 20th, 2011 08:39

    I like the tips how to build a Zero Based Budget. THX!