Maybe this has happened to you.
You sit down at the beginning of the month and make a budget. You imagine how much you're going to make and how much you'll spend. You're thorough with it, and when you're finished, you're happy to see you have $500 left over.
Now, if you're like most of America, you'll likely see this as "extra" money and spend it on something you don't need. But if you're more financially savvy, you can actually take that money and put it back in your budget.
How do you do that? Simple. Make your budget a zero-based budget.
What is a zero-based budget?
Simply put, a zero-based budget means income minus expenses equals zero. In other words, what you earn matches what you spend, save, and invest. For example, if your monthly income is $5,200, a zero-based budget might look like:
- Debt Payments: $600 (5,200 – 600 = 4,600)
- Food: $820 (4,600 – 820 = 3,780)
- Utilities: $520 (3,780 – 520 = 3,260)
- Mortgage/Property Taxes/Insurance: $1,400 (3,260 – 1,400= 1,860)
- Transportation/Car Maintenance: $500 (1,860 – 500 = 1,360)
- Contributions to 401(k)/Roth IRA: $800 (1,860 – 800 = 560)
- Shopping: $270 (560 – 270 = 290)
- Emergency Fund Contributions: $290 (290 – 290 = zero)
Notice every dollar has a purpose. That's the beauty of a zero-based budget: you're not done budgeting until your paycheck balance is zero.
Why use a zero-based budget?
A zero-based budget gives you maximum control over your finances: you know exactly where your money is going, and if done right, you've put your money in the right places. Additionally, here are three advantages to using this method.
- It gives every dollar a plan, including "leftover" money.
A traditional budget doesn't tell you what to do with extra cash. After listing all of your expenses, you may have $500 left over, which could encourage you to spend it on something you don't need. A zero-based budget accounts for this, helping you build your financial goals into the budget.
- It helps you stop overspending.
A zero-based budget can help you overcome emotional spending. Sure, you may really want that Halloween costume for your dog, or that new pressure cooker for your kitchen. But if it pushes your budget into negative numbers, you know it's not worth it.
- It breaks the paycheck-to-paycheck cycle.
A zero-based budget is based on the money you earned the month before, not money you expect to earn. Yes—this gives people a head tilt. Most people live paycheck-to-paycheck, paying bills as they earn income. A zero-based budget breaks this cycle. At the beginning of each month, you use the money you've already earned to plan out how much you can spend, which, in turn, discourages you from overspending.
How do you make a zero-based budget?
Grab your pen and paper, start a new spreadsheet, or open your budgeting apps, because now is the fun part—we're going to make a zero-based budget in four easy steps.
- Find out what you're spending your money on.
First, look at bank transactions from the last several months and find out where your money is going. Write down every expense category that makes sense for you. Don't forget to include personal savings accounts, savings for your kids' colleges, retirement contributions, and investments.
Your categories may include:
- House Maintenance
- Car Repairs/Maintenance/Registration
- Insurance Premiums/Deductibles
- Pet or Child care
- Travel Expenses
- Bank Account Fees
- Emergency Fund Contributions
- Investment & Retirement Contributions
- Holiday & Birthday Gifts
- Charitable Donations
- "Fun" Money
As you're figuring out what you're spending your money on, pay attention to how much you're spending on each item. This will help you later when you're assigning each category a dollar amount.
- Find out how much you're spending a month.
Now that you know what you're spending your money on, it's time to figure out how much you're spending a month. Again, look at your bank transactions. If your spending has been irregular every month, add them up and take the average. Then, adjust the number based on your intuition. For example, you may have spent $5,000 in May, $5,600 in June, and $7,800 in July. After you calculate the average—$5,800—you decide to set your monthly expenses at $6,000, which feels right to you.
- Save a month's worth of expenses
Next, put a month's worth of expenses aside. Yes, this may take a few months, especially if you're living paycheck-to-paycheck. That's okay—it's worth it. Set aside a little every month, until you have enough to cover an entire month of expenses.
- Assign every dollar a job.
Finally, it's time to give every dollar a purpose. Go back to your expense categories. Based on what you've spent in the past, assign each one a reasonable amount. Remember: you cannot spend more than this amount. So take your time and allocate the right amount to each.
As you're putting money aside, you may find you're spending way too much on one thing, such as eating out, and not enough on another, such as investing. Now is the time to correct this: move money around until your budget helps you accomplish your financial goals.
Alternatively, you may find that you're contributing too much to your retirement accounts. This isn't a bad thing (go you!), but you definitely don't want to deprive yourself of "fun" money. Move some back to your entertainment category, or, if you have enough in your entertainment category, give some to a local charity or church.
Need help with cashflow?
A zero-based budget helps you manage money you already have. But if you're looking for ways to get more money, we can help. Thinkflow helps you manage cashflow, as well as find side-gigs and higher-paying jobs to increase it. Get Thinkflow today and take control of your financial future.