Zero-based budgeting: How does it work?

Does it seem like you spend your paycheck quickly? Do you want to have more money for savings, debt payoff or long-term goals? Then you might benefit from creating a budget to manage your money.

But where do you begin? There are many different ways to create a budget. You could consider whether zero-based budgeting works for you. With this budget method, you start from scratch and decide where you want every dollar to go. 

Key takeaways

• Zero-based budgeting allocates every dollar of income.
• It’s different from traditional budgeting because it starts with a new budget, typically each month, instead of using the previous budget as a starting point.
• Zero-based budgeting can help you make thoughtful decisions about how to use income.
• Creating a zero-based budget can take time, discipline and attention to detail.

Zero-based budgeting, also called ZBB or zero-sum budgeting, is a type of budget that allocates every dollar of income, from expenditures to savings. It starts from scratch with a new budget—typically each month—to track expenses and manage money. 

Zero-based budgeting began in 1924, possibly earlier, and the federal government adopted the method in the mid-1970s.

Major corporations caught on, and today businesses primarily use zero-based budgeting, but individuals and families can use it as well. The concept is the same: Income minus expenses and savings equals zero.

Say someone makes $3,000 a month. They could allocate $2,000 for bills, $500 for savings and $500 for fun. All income is allocated for a specific category. And if their car breaks down and they need $200 for repairs, they could take that amount from savings or fun money, still leaving them with $300 for that fund. Going through this budgeting process may also help you be more aware of where your money is going.

Not everyone has a steady income from a salaried job. Some people work an hourly job with a changing schedule, so their paycheck is different every time. Others receive commission, and their income depends on whether they make a sale. And some people work overtime or do side gigs for extra income when they can. 

While zero-based budgeting could be more difficult for people who make a different amount of money each month, it’s possible to make it work.

To calculate an irregular income, it’s a good idea to add the least amount made at each job for a conservative estimate so you’re not short at the end of the month. You could also consider a money-tracking app to keep track of income and expenses.

If you earn more income than expected, you could allocate that money however you want.

Setting up a zero-based budget starts with adding up your income and evaluating, categorizing and prioritizing your expenses. 

Once you are ready to create your zero-based budget, think of all the different income sources you could put in the plus column of your budget. You could look at your W-2, past paychecks and bank statements showing deposit amounts. 

Add up things such as:

• Wages or salary
• Tips and commissions
• Profits from selling goods
• Pay for performing services, including side gigs
• Interest or dividends on investments
• Gifts, allowances or inheritances 
• Alimony and child support
• Government benefits and tax refunds
• Retirement or pension income 

As a next step, make a list of your expenses. You might want to look at past bills and receipts. Some bills, like rent and streaming services, are the same amount each month. For bills that are different every month, such as water and electric bills, you might want to calculate the monthly average by adding all past bills and dividing the total by the number of months.

Your expenses may include:

• Rent or mortgage
• Utilities 
• Insurance 
• Groceries
• Childcare
• Transportation 
• Payments for credit cards and loans
• Medical expenses 
• Savings for retirement and emergencies

Some things aren’t essential, but they can make life more enjoyable. Consider how much you would want to spend on things such as:

• Dining out
• Entertainment 
• Clothing
• Household items
• Miscellaneous expenses

Also think about any unusual purchases or special circumstances that might be coming up: 

• Are you going on vacation? Buying food or presents for a holiday or other special occasion? Getting any annual renewal bills? 
• You might also want to consider working on paying off debt by making more than the minimum payment for car, house, or student loans or credit card debt.
• Giving to a charity may be important too, so if that’s the case, you’ll want to figure that into your budget.

However your income is divided among your expenses, zero-based budgeting means allocating every penny. 

If you made more money than you expected, assign it to one or more specific categories until you hit zero. You might consider adding it to your savings, for example.

If you end with a negative balance, that could mean cutting expenses in at least one category. For example, if your water bill is higher one month, you may decide to cook at home more instead of going out to eat. 

Tracking every expense throughout the month could show whether there’s too much, not enough or just the right amount budgeted for each category. 

When you pay the rent or mortgage, you could subtract that from housing. Every time you go to the pharmacy, gas station or grocery store, you could deduct what you spent from those categories of your budget. 

Budgeting can be easier with a tool or template. A variety of software, apps and websites may offer options for creating your own zero-based budget.

Here’s a hypothetical example of a zero-based budget for someone who makes $3,000 a month:

• $1,000 for rent
• $500 for transportation
• $400 for utilities 
• $300 for groceries 
• $200 for insurance 
• $200 for credit card payments
• $200 for entertainment 
• $100 for self-care 
• $100 for savings 

Total expenses: $3,000

Amount left: $0

Being aware of every dollar that comes in or goes out could help in making thoughtful decisions about how to use income and curb impulse buys, for example. 

And breaking down finances into monthly increments might make budgeting more manageable.

Creating the first budget might be time-consuming if you’ve never done it before. Making a new zero-based budget each month can take discipline, attention to detail, and practice. 

For people who have an unpredictable income or expenses, zero-based budgeting isn’t impossible, but it can be challenging.

There’s no shortage of methods you could use to help you plan and get a better understanding of where your money goes each month. And some strategies might even overlap. Here are a few that might be worth researching:

• 50/30/20 budgeting: The 50/30/20 method recommends setting aside 50% of your income for needs, 30% for wants and 20% for savings each month.
• Pay-yourself-first budgeting: Sometimes called reverse budgeting, this method focuses on putting your money toward savings and debt payoff first.
• FIRE budgeting: Short for financial independence, retire early, this movement has several different strategies based on saving and investing large portions of income. 

Traditional budgeting typically doesn’t change month to month, although you may need to make small tweaks here and there. 

Zero-based budgeting allocates every dollar of income, from expenses to savings. It starts from scratch with a new budget each month.  

By allocating every dollar of income before it’s spent, it could help control spending. And the flexibility allows for adjustments throughout the month.

You may want to consider zero-based budgeting as you’re learning more about money management and tracking personal finances.