Zero-Based Budgeting: How to Make Every Dollar Count

Do you want to know where every dollar you earn goes? Give zero-based budgeting a try

Updated: October 31, 2024

Advertising & Editorial Disclosure

What Is Zero-Based Budgeting?

In 2021, Americans lost an average of $1,389 because they lacked sound financial knowledge. There are several components to financial literacy. Budgeting is one of them.

When you create a budget, there are several approaches you can take. Zero-based budgeting is only one of them, where you assign each dollar a job. After subtracting your expenditures from your income, you will end up with zero.

However, not every dime is spent. Yes, it includes expenses and debt repayments, but zero-based budgeting also accounts for the money you set aside for savings.

It's an excellent way to track where your money goes for each budgeting period.

Zero-based budgeting is a method wherein your expenditures equal your income. It involves allocating each dollar to a category: necessities, wants and savings.

Some businesses use zero-based budgeting to determine each department’s budget, but it's also applicable when managing your personal finances.

Zero-based budgeting is an effective way to track where your money goes for each budget period. You'll know where you spend the most, helping you determine where to cut costs.

Zero-based budgeting considers your income and financial goals, making it easy to apply in real life.

Zero-based budgeting can be tedious because you need to account for every dollar each budgeting period. However, in time, it allows you to see spending patterns and may help you develop strategies to save.

Understanding the Zero-Based Approach

Being financially healthy means learning to manage a budget, but that's easier said than done. Zero-based budgeting is only one of several approaches, but it's worth considering if your goal is to see where your money goes each budget period.

It's also known as zero-sum budgeting, given that once you subtract your expenditures from your earnings, you'll end up with $0. Another reason why it's called zero-based is that you start your budget from scratch each month.

After several months, you can spot patterns in your cash flow. It'll be easier to see where you might need to manage your spending.

That said, it's not the most convenient budgeting strategy. For example, the 50/30/20 method is more straightforward but may not work for those with debt.

Zero-based budgeting makes it easier to consider debt repayment strategies like the debt snowball approach or the debt avalanche method. It's an excellent tool for tracking your expenses and increasing your savings.

How to Use Zero-Based Budgeting

Zero-based budgeting doesn't have to be complicated. It does require much patience and can be better suited for naturally detail-oriented people. However, even if that’s not you, zero-based budgeting can be a helpful method or a stepping stone in finding the right fit.

MoneyGeek detailed the steps you must take to apply zero-based budgeting. We covered the essential elements, such as considering your income, coming up with categories and allocating your expenses and other financial commitments to those categories accordingly.

In the end, there are only five steps to zero-based budgeting.

1
Consolidate and Establish Total Income
First, take stock of all your sources of income. If you're earning from multiple jobs, you'll have to include them. How much comes in each month will be the amount you'll allocate later, ensuring you don't spend more than you earn.
2
Track Expenses for a Couple of Months or Use Previous Month’s Record
Next, you need a clear picture of your monthly expenses. Ensure you track your expenditures for several months. This way, you'll know which ones are constant and whether or not you have variable costs. This step sets the stage for steps three and four.
3
Identify Necessities, Wants and Savings
From your list of expenses, categorize them as follows:
- Necessities (rent, food, utilities, tuition fees, debt payments, etc.)
- Wants (travel fund, things on your wishlist, etc.)
- Savings (401k contribution, savings account, emergency fund, etc.)
If you can, break these three broad categories down even further. It’s better to itemize expenditures under each category. Remember, the more detailed you are, the easier it will be to manage.
4
Allot for Each Category
When allotting your income, prioritize your necessities and financial goals. For example, you can allocate a considerable amount to your savings if you have a big purchase on the horizon.
Remember, whatever amount you allot is how much you can spend in each area for the coming month.
5
Spend Accordingly Until Your Budget Equals Zero
Doing steps one through four ensures you have your limits ready by the time the next month begins. It's best to keep your expenditures within your allocations. However, should there be any unexpected costs, don't forget to add a category and update your budget. At the end of the month, you can do a quick review to ensure that you are effectively budgeting toward zero.

Using Zero-based budgeting to manage your monthly expenses allows you to spot patterns. Over time, you can see from which category you spend the most. From there, you can adjust your allocations for the following months.

There are also short-term advantages. For example, if you have a medical emergency, you can quickly adjust your budget to accommodate it. Of course, it means taking funds from other areas (usually your wants) to end with zero. You may have to shift your allocations around, but it'll help you avoid spending more than you earn.

Zero-Based Budgeting in Practice

There's no better way to understand zero-based budgeting than seeing how it applies in real life.

Let's look at Rich, a 35-year-old project manager planning to propose to his long-time girlfriend. Here's how he uses zero-based budgeting to achieve his financial goal while meeting all other financial obligations.

Step 1

Figure out your total income

Rich works full-time as a project manager for a petroleum company. He brings home $5,000 a month. On weekends, a side hustle adds another $1,500 to his income. Although he's been able to live off his earnings, he wants to ensure he can save enough money to buy an engagement ring for his girlfriend.

Step 2

Review your expenses for the past months and categorize them accordingly

Looking at his expenses for the last three months, Rich determines that his current budget is the following:

Necessities

Rent: $1,500
Food: $500
Utilities: $800
Auto loan debt: $900
Credit card debt: $750

Wants

Eating out: $700
Weekend expenses with friends: $1,150

Savings

Retirement plan: $200

Step 3

Be clear about your financial goal

He has his eye on an engagement ring that costs $4,000. Rich decides that zero-based budgeting is the best method for saving enough money without neglecting his other financial obligations.

Step 4

Allocate your income to your expenditures

To put more money into savings for the ring, Rich adjusts the amounts allocated to each category. Keep in mind that his necessities remain the same. Now, his budget is as follows:

Expenditure	Original Amount	Adjusted Amount
Necessities
Rent	$1,500	$1,500
Food	$500	$500
Utilities	$800	$800
Auto Loan Debt	$900	$900
Credit Card Debt	$750	$750
Wants
Eating Out	$700	$250
Weekend Expenses with Friends	$1,150	$400
Savings
Retirement Plan	$200	$400
Engagement Ring (new)		$1,000
Total Expense	$6,500	$6,500
Total Income	$6,500	$6,500
End-of-Month Budget	$0	$0

Expenditure	Original Amount	Adjusted Amount
NECESSITIES
Rent	$1,500	$1,500
Food	$500	$500
Utilities	$800	$800
Auto Loan Debt	$900	$900
Credit Card Debt	$750	$750
WANTS
Eating Out	$700	$250
Weekend Expenses with Friends	$1,150	$400
SAVINGS
Retirement Plan	$200	$400
Engagement Ring (new)		$1,000
Total Expense	$6,500	$6,500
Total Income	$6,500	$6,500
End-of-Month Budget	$0	$0

Step 5

Stay within your limits and repeat the process each month

For the next four months, Rich ensured that he kept to the allocated limits of his zero-based budget. He was able to buy the engagement ring in the fifth month. Rich then revisits his budget and reallocates his income since he now has more available funds.

Benefits and Drawbacks

There is no perfect budgeting tool. Like all other methods, zero-based budgeting comes with advantages and disadvantages. Looking at it from both angles can help you determine whether or not it's something that'll fit your unique financial situation.

BENEFITS

It creates transparency. You'll have a better idea of your household's cash flow. Zero-based budgeting requires you to note every dollar that comes in and out. It'll give you a better picture of where your money is going and allow you to spot spending patterns over time.
It’s flexible. Unlike other budgeting methods that use the previous month's figures as a basis, you start from scratch each month. It allows you to allocate varying amounts to different areas each time. Even if your income changes, you can adjust your budget.
It prevents overspending. Your monthly earnings dictate the total amount you have to work with. You'll never spend beyond your income if you diligently stay within your budget.
It allows you to make immediate adjustments. Expenses tend to fluctuate each month. Diligently tracking your spending may seem tedious, but it allows you to make real-time adjustments. It comes in handy if there are sudden expenses you didn't account for from the previous month.
It considers your financial goals. You have the freedom to allocate how much you can spend for each category (necessities, wants and savings). That means you can assign a higher figure to items that will lead you closer to your financial goal.

DRAWBACKS

It takes up a lot of time. Creating a zero-based budget isn't as straightforward as other budgeting methods. It's not a matter of dividing your income into equal parts. The more detail, the more you get out of your budget in the long run.
It doesn’t work well with variables. Although zero-based budgeting allows for flexibility, it works best if your income and expenses are constant. Since you're basing next month's budget on this month's expenses, this approach doesn't account for variables.
It’s not ideal for first-time budgeters. Zero-based budgeting is typically better suited for advanced budgeters. Approaches like the 50/30/20 or the envelope budget may be better for beginners. You can transition to zero-based budgeting if you've gained more experience and are more comfortable creating and maintaining budgets.
It requires discipline. To reap the benefits of zero-based budgeting, you must carefully track all movements of your funds. It includes calculating your take-home pay to listing all your costs. And you do this for the entire month, not just at the beginning or the end. A great deal of discipline is necessary to make it work.

Is Zero-Based Budgeting a Fit for You?

Only you can determine whether or not zero-based budgeting will work for you. Remember, although it offers many benefits, it's not for everyone.

If you're detail-oriented and won't mind the amount of tracking required, it's a solid option for a budgeting tool. However, if you're attempting to budget your money for the first time, you might find it too complex and labor-intensive.

Budgeting regularly and consistently brings the best results, so it's best if you can stick with your budgeting method of choice for the long run.

Zero-Based Budgeting FAQ

Zero-based budgeting can sound intimidating, but it might be an approach that fits your needs. Here are some commonly asked questions MoneyGeek gathered if you need more information.

What is zero-based budgeting?

Zero-based budgeting (also sometimes known as sum-based budgeting) is an approach that requires you to assign a purpose for each dollar you earn. It doesn't mean that you must spend everything. You can contribute more to your savings or emergency fund for any surplus.

At the end of each month (or your preferred budgeting period), subtracting your expenditures from your income must equal zero.

How does zero-based budgeting work?

You can create a zero-based budget in a few steps:

Calculate your total income.
Track your expenses for a couple of months.
Categorize your expenditures as necessities, wants or savings.
Allocate your earnings to your expenditures — you should arrive at zero when subtracting your spending from your income.
Don't exceed the allocated amount per category.

It may take some getting used to, but the trick is to track the usage of your funds religiously. Repeat the process for the following month.

Give it enough time, and you'll start seeing patterns in your spending. It may be just the right fit for managing your finances.

Can you still use zero-based budgeting if your income is irregular?

Yes, although you'll find yourself making adjustments each month. However, that's the beauty of starting from scratch every time. Your income and expenses from previous months can serve as a guideline, but you can adjust them based on current numbers.

What are the advantages of zero-based budgeting?

There are several benefits to using zero-based budgeting, such as tracking your expenses so you'll have a clear picture of your household's cash flow.

You can also anchor your budget to your financial goal. So if your primary objective is to pay off your credit card balances, you can allot more to your debt repayment category.

What are the disadvantages or foreseeable challenges of zero-based budgeting?

Like all budgeting methods, there are some things about zero-based budgeting that might not make it a good fit. For example, the level of detail it requires for tracking and recording can be complicated for first-time budgeters.

The constant recording and adjusting are tedious and time-consuming. Some might prefer a more straightforward strategy, like the 50/30/20 approach or the envelope budgeting method.