Zero based budgeting: What it is and why you should be doing it

What is zero-based budgeting?

Zero-based budgeting means that every dollar of income you have coming in must be accounted for in your budget.  Every dollar is given a purpose by being allocated to specific expenses, savings or debt repayment.

A zero-based budget follows this simple formula:

Income minus spending minus debt repayment minus savings equals zero.

It is a powerful budgeting process that ensures you know where every dollar you earn is going.

Zero-based budgeting is an incredibly effective way to force yourself to spend within your means, save money and pay off debt. By ensuring that you don’t skip any priorities, you are much more likely to meet all your financial goals.

How do you make a zero-based budget?

A zero-based budget is no harder to create than any other form of budgeting. Our guide on how to create a budget has all the tools you need, including a downloadable excel spreadsheet.

1. List all your monthly income sources.

Include your paycheque, social assistance, child or spousal support, pension income, business income, rental income, and any other cash you bring in.  If you earn commissions, estimate on the low side. If you earn more or get a bonus, we recommend excluding this initially.  This provides some buffer in your planning and ensures that you don’t go negative right off the bat.

2. List your monthly cash outflows.

If you don’t know where you are spending your money today, start with a 30-day spending journal. Look through all your past credit card and bank statements and utility bills for ongoing expense items. In addition to the big three – rent or mortgage, food, and transportation – be sure to include all memberships, an amount for personal care, prescription medications, and anything you spend money on.

Don’t forget to include periodic or seasonal expenses like insurance premiums, property taxes or gifts.

Remember also to list all the money you spend each month either paying off debts or putting towards your savings.

To get started, download our Excel Budgeting Spreadsheet, which we’ve pulled together to help you compile and organize your income and spending.

3. Subtract your outgoing spending from your income to get to zero.

Once you have a clear picture of exactly what money you have coming in and out each month, it’s time to balance them to equal zero. Your initial budget might reveal that you are spending way more than you have coming in.

To get your budget to balance you can:

  • increase your income
  • decrease or redirect expenses
  • increase or decrease debt repayment. Remember however that you must keep up with all minimum payments.
  • increase or decrease your savings

Ultimately, it’s your zero-based budget. Your rules. It could be that you put aside a large chunk towards your savings, or you could simply give yourself more money to spend on a vacation. All that matters is that you clearly assign the money somewhere – otherwise, you’ll simply spend it on a whim on who knows what, and then it’s just money you’ve unexpectedly frittered away.

However, keep in mind your initial goals. Do you want to eliminate debt? Do you want to increase savings?  When choosing where to spend your money, make sure you meet your very specific financial objectives.

4. Track and save.

All that’s left to do now is to track your progress throughout the month and see how your spending aligns with your zero-based plans.

We suggest keeping a daily track of what you are spending. Use whatever budgeting system works for you – the envelope method, a spreadsheet or an app.

Don’t worry if you have a few slip-ups. Simply deduct your overspend from the money that you have allocated to other categories, et voilà! – your budget should still total zero at the end of the month.

What are the benefits of zero-based budgeting?

Creating a zero-based budget is a powerful way to put you in control of your finances. You consciously decide exactly where and how you are going to spend every cent you make, which in the long run will help you to achieve your financial goals.

Zero-based budgeting is absolutely not about taking away your financial freedom. It’s about putting you in charge of your budget so that you can enjoy more of the things you love, without worrying about a nasty surprise at the end of the month.

Does zero-based budgeting mean zero flexibility?

No, absolutely not. At any time, you can tweak how and where you allocate money throughout the month. Priorities and situations change, and your budget can and should adjust accordingly.

The best thing about zero-based budgeting is that you get to spend your money guilt-free. If you have allocated $100 to your restaurant fund for the month, then by actually spending that money you are simply sticking to your budget. Rather than feeling guilty, you can spend your money stress-free, safe in the knowledge that you’re only ever spending within your means.