Zero-Based Budgeting

February 1, 2010 · Posted in Budgeting Tips, Personal Finance

Photo Credit: Jeff Keen

A zero-based budget is one where your total income minus your total expenses equals $0. In other words, it forces you to assign every dollar of income to an expense (or savings) category. In business, a zero-based budget starts from a “zero base” and every function within an organization is analyzed for its needs and costs. Budgets are then built around what is needed for the upcoming period, regardless of whether the budget is higher or lower than the previous one.

Zero-based budgeting is basically putting a name to every dollar that comes your way. It starts with your income side of the equation, and line by line, the total subtracts as you allot amounts to each category, until you are down to zero.

The term “zero-based budgeting” is sometimes used in personal finance to describe the practice of budgeting every dollar of income received, and then adjusting some part of the budget downward for every other part that needs to be adjusted upward. It is more technically correct to refer to this practice as “zero-sum budgeting”.

Zero based budgeting is an alternative approach that is sometimes used particularly in government and not for profit sectors of the economy. Under zero based budgeting, managers are required to justify all budgeted expenditures, not just changes in the budget from the previous year. The base line is zero rather than last year’s budget.

Zero based budgeting also refers to the identification of a task or tasks and then funding resources to complete the task independent of current resourcing.

Advantages of Zero-Based Budgeting

Efficient allocation of resources, as it is based on needs and benefits.
Drives managers to find cost effective ways to improve operations.
Detects inflated budgets.
Useful for service departments where the output is difficult to identify.
Increases staff motivation by providing greater initiative and responsibility in decision-making.
Increases communication and coordination within the organization.
Identifies and eliminates wasteful and obsolete operations.
Identifies opportunities for outsourcing.
Forces cost centers to identify their mission and their relationship to overall goals.

Disadvantages of Zero-Based Budgeting

Difficult to define decision units and decision packages, as it is time-consuming and exhaustive.
Forced to justify every detail related to expenditure. The R&D department is threatened whereas the production department benefits.
Necessary to train managers. Zero-based budgeting must be clearly understood by managers at various levels to be successfully implemented. Difficult to administer and communicate the budgeting because more managers are involved in the process.
In a large organization, the volume of forms may be so large that no one person could read it all. Compressing the information down to a usable size might remove critically important details.
Honesty of the managers must be reliable and uniform. Any manager that exaggerates skews the results.

How to create a zero-based budget?

A budget should more or less have the same categories each month, even if you don’t always fill those categories with money. The main types of categories you should have are:

Income
Regular expenses, and
Irregular expenses

Make sure and account for any type of income, not just your paycheck. As an example, my categories under “income” are:

paycheck
book advance
gift received
blog
surplus from previous month
work advance, and
work reimbursements

Your regular expenses are pretty much what you think of as expenses — utilities, rent or mortgage, groceries, entertainment, and the like. You should also include your allotment for whatever step you’re on — your debt snowball if you’re on step 2; contribution to savings if you’re on step 3.

And don’t forget free spending money. Give yourself a set amount of cash you get to keep in our wallets and spend on whatever we choose. It’s not much money, but it’s enough for a coffee here and there, a magazine when you see one, or whatever. It curbs your appetite for random spending, and it helps you keep to the budget.

It’s important to plan for irregular expenses as well — these are funds that you don’t need each month, but you want to set aside for them regularly so that you have enough cash when you need it. These are also called sinking funds. Some of our family’s sinking funds are:

books
Christmas
clothing
gifts and holidays
haircuts
medical (insurance deductible)
vacation
work expenses

Planning Your* Budget*

If you don’t work from a budget, I encourage you to do so. In a way, you already are, you just may not be aware of it. Your money’s going somewhere; writing it down into a budget form simply allows you to premeditate where it should go. A few tips as you prepare:

• Use a tool that works with your style. A pen and paper might be more your style, but there are budget-tools site in the internet that you can use— it doesn’t really matter.

• Don’t expect it to work perfectly the first time, or at any time. This is an easy mistake, and one that can cause you to think you’re doing something wrong. You’re not. It takes awhile to get the hang of knowing how much money to allot for different line items, and there are plenty of times when your needs change mid-month. Stay flexible.

• Work with your pay periods. If you get paid more than once a month, perhaps it’s easier if you create a different budget for each paycheck, setting aside a percentage for those monthly bills. Do what works for you, so that you’ll do it.

• Don’t be under-specific, but don’t be too specific. It’s easy to have a subcategory for every single need. It’s also easy to generalize. Find a happy medium.

• Account for everything you’re spending, and give it a name. Don’t have a category called “miscellaneous.”

So the next question to consider is – if you were to write a zero-based budget for your family every month, would you keep track of it? Do you just set the paper aside and hope for the best? Do you walk around with it in your purse, analyzing every single number until you’re cross-eyed walking around Target and scared to death of putting anything in your cart?

I encourage you – prepare a zero-based budget as part of your home management every month. And then regularly, enter your expenses to stay on top of how well you are sticking to your budget. As the month progresses, you can see how well – or not so well – it’s working, and tweaks it from there. It doesn’t take much time when you stay on top of it.

This is also infinitely easier to do when you have a smart, simple tool that subtracts expenses from your budget as you record them. I prefer a tool that’s as light and easy-to-use as possible. No bells and whistles that I really don’t need for everyday family finance management. Try the budget tool of Inzolo.com. It’s the simplest way of budgeting your money online.

REFERENCES:

http://en.wikipedia.org/wiki/Zero-based_budgeting

http://www.investopedia.com/terms/z/zbb.asp

http://www.gettingfinancesdone.com/blog/archives/2006/08/how-to-create-a-zero-based-budget/

http://www.accountingformanagement.com/zero_based_budgeting.htm

http://simplemom.net/zero-based-budgets-for-the-home/

http://simplemom.net/the-basics-behind-a-budget-that-works/