Zero Based Budgeting

How to Make a Zero-Based Budget

A Zero-based budget (an idea I have borrowed from Dave Ramsey) is simply a way to account for everything you have coming in, and everything you have going out. And the formula for making sure those two are the same is remarkably simple.

Zero-Based Budgeting:
(Everything coming in) - (Everything going out) = 0
Confused? You shouldn't be.

Tweet

1. Everything Coming In

Write down every bit of money you have coming in every month. All income from every source. Wages, tips, salary, debt repayments, everything. If it comes in once a year, divide it by 12 and add that to every month. All you need is an amount coming in every month that you can use as a basis to start your budget.

2. Everything Going Out

Write down every payment you have to make every month. This could be rent, mortgage, phone bills, cable bills, debt repayments, student loans, credit card bills, everything. Every single payment that you need to make every day, week or month. If you pay it yearly, divide it by 12 and put it into the month.

What if you don’t know how much you spend on something? Like food, gas, or electricity?

Go through your bank statements for the last 12 months. Add up your amounts that you spend on that thing every month and divide by 12.

3. Figure Out the Difference

If your going out is already more than coming in, then you need to stop at this paragraph and make changes to one of two things:

Less Going Out
More Coming In

4. Budgeting the Difference

Once you have more coming in than going out, you need to figure out what to do with the difference. A Zero-Based Budget means you are assigning a function to all your dollars. If you have more coming in than going out, and no plan, that’s also not a Zero-Based Budget. More than anything else, a Zero-Based Budget is a plan.

If you have $5,000 coming in monthly, and $3,000 going out, you need to budget the other $2,000. Here’s some ideas on what to assign the money to:

-Expected Disasters (roof repairs, painting your home, regular car maintenance)

-Unexpected Disasters (home, health, auto)

-Upgrading (home, auto, vacation, eating out, hobbies)

-Giving (both personally and charitably)

-Investing (short and long term 401k)

The thing about disasters in this system is that they all become expected. All disasters are planned for at least as much as you can. Expected maintenance is already funded, and unexpected problems are (hopefully) fully funded before they happen. This turns a car breakdown into a non-issue since you will have money sitting in an account just waiting to be spent.

5. Stick To The Plan

Now that you have a plan for how much you are going to spend every month on food, spend that amount every month on food. This takes a few monthly cycles to get used to, but with planning and purpose, you will no longer check your bank account to see if you can afford something, you check your budget. Budgeted $400 for food bills this month and spent $200? You have $200 left to spend on food.

Budgeted $300 for car maintenance this month and had no car repairs? It stays in the account and accumulates every month so that when you have a car repair that costs $1000, you have $2000 in the account set aside just for that. When your car doesn’t break down for a while you almost start to wish it would and think, “What am I doing with all this money in the account?” Resist the urge to spend it, or use some for preventative maintenance. If it never breaks down, use the money to help purchase your next one and keep $1,000 in the account .

6. Save - Don’t Finance

The last step to the system is to plan on making your next large purchase in cash. If you know you need a new car in a year, you need to budget to buy it in cash. If you want a $24,000 car next year, you need to have $2000/ month in your budget set aside for just that one thing. If you can’t afford $2,000/ month in your budget right now, you can’t afford a $24,000 car next year.

If you can afford $1,000/ month in your budget to start setting aside, then you can either wait until you have the amount you want to spend on a car, or you can adjust your expectations on what kind of car you can afford.

Summary and Critiques

The most vocal critique for this kind of budgeting is:

“But now I can afford less car or home or clothing!”

And that is totally false. You can actually afford more. Since you will no longer be buying money (which is exactly what a loan is) you can actually have more to spend. You switch your thinking to earning money, and saving for what you know you want, or need, in the future.