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
  • Electricity
  • Groceries
  • Telephone
  • 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.

13 thoughts on “How To Create A Zero Based Budget

  1. I’ve been using a zero based budget for years, though I didn’t know it had a name. A big part of doing zero based budgeting is a once a month reconcile, since your budgeting is based on estimates. If you spend less than you budgeted there will be money leftover in your bank account, that money needs to be used towards debt or savings or something else or you haven’t zeroed out your account. I did a post with some tips for success with zero based budgets:

    Zero Based Budgeting

  2. I like your 4 step method. I’m going to double check my budget to make sure I’ve covered everything. I’ve tried to make a zero-based budget for years on paper and then with Excel. Some months were more successful than others, but generally I would spend more than I had intended. I just purchased YNAB (excel version) in Dec., and I love that it keeps me accountable if I overspend. I also find it easier to budget for irregular expenses because I can see the totals all the time.

  3. I read about zero-based budgeting a few months ago. So now, I allot a certain amount of money for necessities and anything left at the end of the month goes to my ING account. It is a great motivator to keep spending in line.

    So x% of my net income goes directly to ING at the beginning of the month and I watch my money like hell to have a few hundred left to add at the end of the month.

    If I budget say $400 for fuel oil and only have to pay $350, I take the remainder and off to ING it goes. For those kinds of transfers, I don’t even wait till the end of the month.

    This is a good plan to follow. Watching that money grow in savings is almost like an addiction.

    Thanks for this post and for reinforcing the benefits of zero-based budgeting.

  4. Very good explanation indeed. :twothumbsup:

    YNAB saved my life…literally. I can’t recommend it enough. And I have to thank NCN for leading me to it.

    We went from being 30K+ in debt to living debt free in a little over a year. Now my wife stays at home with our kids and we live quite comfortably on my income alone. I COULD NOT have done this without YNAB and NCN. Thank you to all.

  5. Hi there.

    This is a really solid post about budgeting.

    I’d like to add the following about annual expenses (#3). Once an Annual expense is paid, the allocation needed for each pay check depends on whether one is paid monthly or fortnightly.

    To illustrate this I am going to use a life insurance premium payment of $620.00 (for 2009).

    A monthly pay check means the following allocation – $620.00/12 = $51.67

    A fortnightly pay check means the following allocation – $620.00/26 = $23.85

    (Both of the allocation figures have been rounded up).

    Another point to be mindful of is whether the premium cost increases each year. This means the allocations will need to be calculated from the predicted increased cost of the life insurance. In other words don’t save the 2009 cost for the 2010 cost, make an educated prediction of the 2010 cost.

    So, hypothetically speaking, if during the previous few years the life insurance policy had increased by 5% a year then the allocations would be as follows:

    A monthly pay check means the following allocation – $651.00/12 = $54.25

    A fortnightly pay check means the following allocation – $651.00/26 = $25.03

    I’ve been using my style of zero-based budgeting, well before I came across this term, for just under a decade and a half, and allowing for annual increases in certain financial commitments is the best preventative tool for not being caught short by annual increases.

    I have 2 different insurance payments that are paid monthly by direct debit. I’ve always allocated slightly more than required each fortnight. This means that when the policy is due for renewal each year I have accounted for any annual increase in the monthly payments.

    I hope the above information enhances this post.


  6. Great post on the zero-based budget – one of my favorite budgeting tools! I’ll definitely be bookmarking this one!

    Starting our own zero based budget was one of the best financial decisions we’ve ever made. It really forces you to realize where the money is going, and it can be very eye opening sometimes..

  7. This is a great explanation – can you use this concept with tools like Quicken or Mint? I would love to have an automated tool to drive the zero based budget formula.

  8. I use the zero based budget too. I have a category in my miscellaneous called ‘overages’ and if I spend less on food for the month this shows up in Excel as an overage in the budget. This amount gets transferred to an overage account in ING and every couple of months I raid it to make a snowflake payment to a debt.

  9. I’m not sure I understand how to budget for some of our utilities that fluctuate substantially. For instance, our natural gas can be around $250 in the winter months, but only $25 in the summer. How do I do this?

  10. So it is recommended to use YNAB, just not the “rule one” of it. Ergo, budget all to complete zero, do not create a buffer and eventually live off of last month’s income? I would agree that the money would be better server, either going to your snowball….or to an emergency fund / savings.

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