Whether you’re earning a few thousand rupees each month or millions, it helps to know how to plan your spending. Planning does not only help you make the present better, it helps secure your future too.
Zero-Based Budgeting (ZBB) is an easy and effective budgeting technique you could use to plan your finances. The template it provides can be of great help to people of all income brackets. And companies find it useful, too. Companies like General Motors and Signet Jewelers use ZBB to reduce costs and justify spending on every item on their budgets.
What is a zero-based budget and why is it important?
Zero-Based Budgeting (ZBB)—also called zero-sum budgeting—is a way to budget that encourages you to use all your revenue, down to the last cent. It helps you plan your expenses based on needs and costs.
ZBB starts from “point zero” or a zero base—from where all budgeting decisions are built—in every budgeting period. In every budgeting period, the person who wants to create the budget will thus have to start from scratch and take into consideration all expenses, including any savings or debt repayments that are due.
This budgeting method ensures that all the monetary needs of the period are met and that the focus is again brought back to aspects that are important. Budgeting is done in such a way that in the end, you have no money left unused.
How does zero-based budgeting work?
This budgeting technique helps lower costs by not using the kind of blanket sums that were commonly featured in previous budgets. Instead, ZBB starts by taking into account all the functional areas.
In an organization, for example, this kind of budget will examine the expectations along with the specific areas for which funds are being allocated. ZBB is therefore highly detail-oriented. In this, ZBB is different from traditional budgeting.
Organizations or individuals using this method focus on short-term projections that the budget should meet.
Steps to create your own zero-based budget
1. Examine all your income streams
The first aspect of the ZBB method is to look at all your income. Listing all the income coming in helps you understand how much you have to work with.
2. Consider all expenses
The ZBB method works with the belief that every period of budgeting or month is unique. This means that you ought to only take into account expenses that are due in the upcoming period. Compiling all your expenses for the period helps you identify expenses that need covering. Expenses could include ventures, savings, one-off payments, and debt repayments.
3. Create categories for your expenses
Looking through and making sense of a long list of uncategorized expenses can be tedious. Identifying broad categories of expenses will help you spot any missing options faster. Your categories could include:
- Mandatory expenses
- Optional expenses
- Debt repayments
- Savings
4. Start settling all expenses
Once you have all your expenses together, start putting your money to work. This is the most important step of zero-based budgeting since your goal is to ensure that you settle all the expenses to avoid deviating.
After you take this step, you’ll realize that one of two things will happen. You might realize that you have leftover funds or that you’re spending more than you earn.
5. Track your expenses
Once you learn the direction your budget is headed (over or below budget), understanding where you missed additions will be easier.
The zero-based budgeting approach is flexible, which means you can easily identify areas that need cuts and where you must allocate more. The ability to track where your money is going makes the ZBB method great for savings since you can locate and cut unnecessary expenses.
Zero-based budgeting example
The figure below presents an example of zero-based budgeting for individuals. Note that the costs section is empty since every individual’s earnings and expenses/needs are different.
|
Category | Expense |
Costs |
| Mandatory expenses | Rent | |
| Utilities | ||
| Groceries | ||
| Medical expenses | ||
| Pet supplies | ||
| Insurance | ||
| Optional expenses | Dining out | |
| Subscriptions | ||
| Haircuts | ||
| Savings | Emergency fund | |
| Vacation fund | ||
| Down payment for a house | ||
| College fund | ||
| Debt repayment | Credit cards | |
| Auto loan | ||
| Medical debt | ||
| Extra debt repayments |
During economic downturns, companies fall back on the zero-based budgeting method as a strategy that allows them to focus only on their vitals. ZBB helps a company to truly evaluate its spending decisions and encourages them to reduce spending where there are cheaper alternatives.
For example, a company that spends $20,000 on hiring an advertiser for marketing might realize that they can save on the budget by doing it internally or hiring cheaper. A different advertiser might charge $10,000, freeing up a sizeable sum. Money saved can be redirected towards something more pressing—like improving packaging or product quality.
ZBB makes it possible for organizations to identify problem spots and provides a guide on the best ways to address them.
Zero-based budgeting vs. traditional budgeting
Zero-based budgeting differs from traditional budgeting in relation to five aspects: the starting point, the complexity of format, its approach to budgeting, cost-effectiveness, and its justification of expenditure.
| Traditional Budgeting | Zero-Based Budgeting | |
| Starting Point | Uses the previous period or year’s budget as the base. | Starts at zero. |
| The Complexity of Format | Is simple since it follows the same format as the previous year. | Is complex since it requires a fresh examination or evaluation of expenses and revenues each year. |
| Approach to Budget | Budget based on historical information or evidence gathered through accounting. | Budget based on future estimates and the evaluations of decision-makers. |
| Cost-Effectiveness | Mirrors the spending or costs from the previous financial period. | Aims to achieve cost-effectiveness through flexibility. |
| Justification of Expenditure | Existing projects don’t require any justification for allocated amounts. | Each proposed project needs to be justified based on benefits and costs. |
What are the four characteristics of zero-based budgeting??
ZBB is easy to use and helps you rethink your expenses. This goes a long way in starting you on your saving and investing journey. And it has some great advantages for companies, too.
- The method ensures that spending aligns with the company’s present plans and strategy.
- This kind of budget provides a framework to guide spending, so that money reaches the projects or departments that bring in the most value and misallocation is avoided.
- ZBB encourages collaboration within a company. It brings together department heads and all financial directors while evaluating what works and what doesn’t.
- ZBB helps with cost reductions. Avoiding blanket sums during budgeting, this method promotes savings.
What are the limitations of zero-based budgeting?
Creating and implementing a ZBB can be too time-consuming. It may additionally be costly for companies. Large organizations can afford to hire expensive experts to scrutinize every department of the company, but smaller organizations may find this hard to do.
As far as companies are concerned, ZBB might negatively impact the brand image. Since companies turn to ZBB to battle tough times, the tough decisions the method proposes might harm its image and culture.
Further, ZBB is a bit complex and laborious. It requires an in-depth examination and an understanding of the needs and goals.
Conclusion
We hope that this article has helped you weigh the pros and cons of this budgeting method and has inspired you to start using it. But if it hasn’t, we would like to encourage you to look for one that’s better suited to your needs.
Planning is an extra task for sure, but once you get the hang of it, it will make life a lot simpler.
FAQs
What do you mean by zero base budgeting?
Zero-based budgeting is a method where each expense is justified from scratch, without assuming previous budgets. It helps prioritize spending based on current needs and goals.
What are zero based budgets examples?
Sure! Imagine you’re planning a trip. Instead of assuming last year’s expenses, you’d start fresh. Decide essentials like flights, lodging, food, entertainment based on current costs and needs.
What is zero-based budgeting UPSC?
In the context of UPSC (Union Public Service Commission) exams, zero-based budgeting refers to a budgeting approach where government departments justify every expense to ensure efficient resource allocation and accountability.
Why zero-based budgeting differ from traditional budgeting?
Zero-based budgeting starts from scratch, justifying every expense anew. Traditional budgeting uses previous budgets as a baseline. Zero-based focuses on needs, while traditional may lead to unnecessary spending due to prior allocations.
