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How to Create a Zero-Based Budget and How It Works

Create a budget where “spending” every dollar is good.

Justin Cupler

Contributing Writer at Tally

October 29, 2022

Budgeting can be one of the more challenging parts of adult life. Fortunately, many budgeting methods make the process easier. Zero-based budgeting, often shortened to ZBB, is one such method that uses specific financial goals as its driver. 

Below, we’ll explore how to create a zero-based budget and how it differs from traditional budgeting. We’ll also review its benefits and drawbacks, so you can decide if it’s the right technique for you. 

What is zero-based budgeting?

Zero-based budgeting (also called zero-sum budgeting) is a personal finance strategy that ensures you "spend" every dollar of your monthly income and not a penny more. 

Spending every dollar doesn't mean blowing it on whatever you like. It means ensuring every dollar you earn goes toward a line item on your budget, even if that line item is a savings goal. This way, when you finish creating your budget, your expenditures equal your monthly income, hence the “zero-based” term. 

For example, if your monthly take-home income is $3,000, you want to adjust your budget so your expenses also equal $3,000. If your zero-based budgeting is off in either the expense or income column, you’re overspending or under-spending, and you must make spending-habit adjustments each month to zero it out. 

In a zero-based budgeting process, you may carry over some recurring expenses from month to month. However, you still create a new budget each month that accounts for extra income and unexpected or variable costs.

How does zero-based budgeting differ from traditional budgeting?

While a zero-based budget system looks forward at expenses and income, traditional budgeting looks backward. Instead of adjusting your budget to reach $0 remaining each month, traditional budgeting uses historical income and expenses.

Traditional budgeting allows little flexibility but is less time-consuming than zero-based budgeting because you set it up at the beginning of the year. Also, traditional budgeting rules only require adjustments when there are significant changes to your income or expenses. 

For example, if you spent an average of $100 per month on electricity last year, you would base your current budget on that number, plus any anticipated rate increases. This number would remain the same for the entire year — barring changes, like a switch to solar panels or moving into a larger home that consumes more electricity.

With ZBB, you would use your actual electric bill to calculate the monthly expense.

How to create a zero based budget

Making a new budget each month and tracking it may seem intimidating. However, in reality, portions of your budget may remain the same each month, such as rent or your student loan payment. The most common changes will be variable expenses like water, electricity and fuel. Once you create your zero-based budget, you'll find it all makes sense. Here's how to create a zero-based budget.

1. Add up all your monthly take-home income

Kick off your zero-based budgeting by first looking at your monthly take-home income. Don't calculate this using your pretax income, as you'll come up short monthly.

If you just started a new job and haven't received your first paycheck yet, you can estimate your take-home pay using a paycheck calculator

If you have irregular income — for example, you work on commission or as a contractor in a side hustle — ZBB shines as a budgeting method because you start fresh each month and can adjust your income to match what you made the previous month. So, if your sales were a little light this month, you can change next month's budget to compensate for that. 

2. Add up your regular monthly expenses

Expenses can get tricky, as you have two types of bills to track: regular and irregular.

Start with the regular bills, which are the ones you pay monthly. These include expenses like:

  • Rent or mortgage

  • Utilities

  • Credit cards

  • Cell phone bill

  • Groceries

  • Car payment and fuel

  • Streaming subscriptions

  • Clothing

  • Entertainment

There’s no doubt you'll run into months where surprise expenses fall into your lap, but we’ll cover that in the next section.


3. Add up your irregular expenses

Irregular expenses are often forgotten until they're due. Fortunately, the zero-based budgeting method puts them front and center along with the rest of your bills. These expenses include longer-term items like:

  • Car insurance payments (semiannually or quarterly)

  • Car registration

  • Vehicle maintenance

  • Property taxes (yearly)

When looking at irregular expenses, calculate their overall yearly cost, then spread that out over 12 months. For example, if your quarterly car insurance is $250, that would equal $1,000 per year, which would break down to $83.33 per month in your zero-based budget. If an irregular bill fluctuates, use the previous year's budget to estimate the yearly cost. 

Other irregular expenses to consider are holidays, birthdays, anniversaries and other times where you plan to spend extra money. If you plan to spend $300 on birthday gifts during the year, break down the amount ($300) by month and put that monthly cost ($25) into your zero-based budget. 

You can account for those surprise expenses that seem to pop up at the worst times with a monthly "miscellaneous" budget. You can base this amount on past unexpected expenses to ease the calculation.

If you didn't track these surprise expenses in previous years, it's OK to estimate. This amount will likely be small relative to your other costs.

When dealing with irregular expenses, set this cash aside for when the expense is due. If you want to take it a step further, create a separate bank account where you can stash this money. 

Putting this cash for your irregular expenses in a savings account can not only keep you from mistakenly spending it, but it can also earn interest as you await the bill's due date.

4. Subtract your expenses from your income

Now for the main event. Subtract your total monthly expenses from your monthly take-home income. If your expenses equal your income, you already have a zero-based budget. 

In most cases, you will either end up with an income shortage or surplus. 

What if I have an income shortage? 

If you have a negative number after subtracting your expenses from your income, you have an income shortage. You can manage this by increasing your income, cutting costs or both. 

If you’re looking to boost your income, start by asking for a raise or trying to work more hours. These options aren’t always available, but they allow you to stay within your current job. If you’re looking outside your current job, you might also consider:

  • Freelancing

  • Driving-for-hire (people or deliveries)

  • Walking dogs

  • Selling crafts or other items

If you’re looking to cut your costs, determine what services you can live without. Start with those you rarely use and continue from there. Even if it's a $1-per-month charge, cutting that expense can make a difference. Look at expenses like streaming services, mail-order video or game rentals, unused software subscriptions and more. 

You can also call your credit card companies to negotiate your interest rates.

If you have a profound shortage, you may have to make more dramatic changes, such as buying a more affordable vehicle with cash or taking public transit where available. 

Continue your cost-cutting until you at least hit the zero-based budget you seek. If you can create an income surplus in the process, that's just the cherry on top. 

What if I have an income surplus?

If you have an income surplus, you're in good shape. But there's still work to do. The goal of zero-based budgeting is to have $0 left in your budget when you're done, so figure out where that extra money in your budget will go. 

This extra cash in a zero-based budget should go toward debt or savings. If you haven't created an emergency fund yet, you’ll want your income surplus to go toward this first.

Most experts recommend having three to six months of expenses in savings to cover emergencies like job loss or illness. However, if you have credit card debt, you can use the surplus income to build an initial $1,000 emergency fund, then prioritize lowering your debt. 

Once you pay off your credit cards and manage any other high-interest debt, you can shift back toward building an emergency fund to cover the recommended three to six months of expenses. 

With the completed emergency fund, you can earmark any surplus income toward retirement savings, savings for a house or car or any other financial goals. 

5. Track your expenses and reset

With your budget firmly set, it's time to track your spending. Categorize and notate every dollar you spend. For example, if you go to the movies and spend $50, deduct that $50 from the "fun money" line item in your budget. 

You can track your expenses in many ways. Some people prefer a simple notebook and pencil. Others may create a spreadsheet or use online budgeting software. 

At the end of the month, review your budget to see where you exceeded or came in under budget. Make any necessary adjustments to your budget the following month.

You will likely make a lot of changes early on. As time passes, you’ll improve your budgeting and financial foresight, reducing the amount of updating you must do each month. Eventually, you may be able to create a monthly budget template that only requires mild tweaks to your income and variable expenses, saving you lots of time. 

Zero-based budget example

Let’s look at an example ZBB and see how it would work in real life. Let’s say Joe takes home $5,000 per month from his full-time job and runs a zero-based budget. Here’s how his actual budget may look.

Is zero-based budgeting right for you?

Zero-based budgeting isn't for everyone, but it’s a great fit for some folks.

If you’re goal-oriented and struggle with traditional budgeting because it lacks the clear end benefit, the ZBB model is perfect. It funnels your money into two primary financial goals to keep you motivated: saving and paying off debt. 

If your income fluctuates because you're on commission or are a contractor, the zero-based budgeting method will suit you because it can change each month. The same goes if you have a lot of variable expenses, like medical bills or home repairs. 

Tracking all of your expenses requires keeping your receipts in order, which can be time-consuming. As such, ZBB is ideal for someone who's organized and enjoys spending time handling their finances.

Pros of zero-based budgeting

  • You can adjust for monthly fluctuations in income and expenses.

  • It assigns a job to every dollar of income.

  • You can focus on key financial goals.

  • It’s more precise than traditional budgeting.

Cons of zero-based budgeting

  • Budgeting can become time-consuming.

  • You can’t automate it. 

  • “Spending” every dollar may make you feel uneasy.

Get your budget started

Now that you understand how to create a zero-based budget, how it works and its pros and cons, you can determine whether it'll fit your lifestyle. Even if it’s not the right approach for you, there's no time like the present to get your budget together. Creating your budget now will help you get your financial life in order so you can reach your financial goals sooner than later.

Is credit card debt throwing your budget off balance and making it hard to keep up? The Tally†credit card debt repayment app can help. The Tally app manages your credit card payments, and Tally offers a lower-interest personal line of credit, allowing you to efficiently pay off higher-interest credit cards. 

To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 to $300.