How To Create A Zero Based Budget
My wife and I use a zero-based budget to manage our finances. At the beginning of each month we discuss upcoming expenses. The budget serves as our plan, allocating money for savings, spending, and debt reduction. Here’s how to create a zero based budget.
1. List This Month’s Income
- Paycheck A
- Paycheck B
- Other Income A
- Other Income B
- Other Income C
I use after-tax income (net pay) when creating our zero-based budget. For those who work as employees, creating a list of income sources should be relatively simple. For those who are self-employed and / or have irregular income, things can get a little more difficult. Personally, a portion of my income is regular (I receive a paycheck) and a portion is irregular (I receive income from my web business). I use the zero-based budget to manage my regular income and another method for managing my irregular income.
2. List This Month’s Expenses
- Rent / Mortgage
- Cellular Phone
- Automobile Payment
- Credit Card Payment
- Donations / Tithes / Giving
- Child Care
List actual expenses anticipated for this month. For categories that fluctuate, we use estimations. We work hard to be realistic. Savings and Accelerated Debt Reduction are covered in step 4.
3. List Non-Monthly Expenses
- Automobile Taxes
- Insurance Premiums
- Magazine Subscriptions
- Annual Memberships
These expenses may not be due this month, but we need to have a plan in place to deal with them, when they are due. We divide the amount of each expense by the number of months between budget creation and the time bill is due. For instance, if we create a budget in March and our life insurance premium of $200 is due in June, we will budget $50, per month for 4 months, for that expense.
4. List Savings Contributions and Debt Reduction Goals
- Extra Payment To Credit Card
- Emergency Fund Contribution
- Roth IRA Contribution
- Education Savings Account Contribution
These are non-mandatory contributions to savings, after-tax retirement accounts, education savings accounts, and accelerated debt reduction payments. For those who are getting out of debt, this is where you would list the extra payment at the top of your debt snowball, debt avalanche, or debt deluge.
5. Subtract Total Expenses From Total Income
Our goal is to create a scenario where total income minus total expenses will equal zero. That’s where the term zero-based (also written zero based) budget originates. Every penny is allocated, prior to actually being spent, saved, or invested.
If we subtract expenses from income, and get a negative number, we need to decrease the amount you allocated for expenses. Consider decreasing non-essential categories, like eating out or entertainment.
If we subtract expenses from income and you get a positive number, we need to increase the amount we have allocated for expenses, savings contributions, or debt reduction.
There you have it. That’s how to create our zero based budget. If you have any questions or suggestions, feel free to leave them in the comments section.
For those new to zero-based budgeting, I suggest outlining your budget on paper and then transferring your numbers to the budgeting software of your choice.