What is Zero-Based Budgeting?
In a nutshell, zero-based budgeting is preparing a budget from scratch, ignoring last month or last year figures and budgeting from the ground up. Zero-based budgeting is not just about budgeting, it is also about planning every expense, telling your money where to go. Whereas traditional budgeting is basically using your existing budget and making changes to it to get to the desired budget.
This method is appealing as it forces you to justify every expense on your budget. As our financial resources are limited each activity must prove its merit to earn a place in the budget. With traditional budgeting, often expenses get carried over into the next budget, it does not mean you will end up spending that amount, it just means that you are not planning your finances efficiently. This is not to say that traditional budgeting does not work, for a seasoned budgeter it may make sense to use the regular budgeting method. But if you are new to budgeting, zero-based budgeting may make more sense as you try to understand the relationship between your income and expenses.
What are the Disadvantages?
As appealing as this may sound from a financial perspective, there is a downside to using zero-base budgeting. The downside is that practically it can be time consuming. There is a fatigue factor which means that building a budget from zero every month can be tiring and can lead to loss of motivation.
What are the Advantages?
Following a set budget month after month is quick, easy, and has an element of simplicity requiring very little effort. While rolling over budget from previous month or year can be tempting, there is an inherent problem that causes inefficiencies to be carried forward.
Zero-base budgeting, on the other hand, requires that you build your budget at the lowest level possible and then add additional spend based on the cost-benefit of the specific activity. In effect, you are incrementally increasing your budget from the lowest level possible to a level you feel more comfortable. This activity highlights your essential expenditures that are included in your base budget, fixed expenses like rent/mortgage, insurance, car payments, any other fixed monthly expenses and then identifying the discretionary expenditures.
The insight this activity provides is invaluable in understanding your financial constraints and your spending habits. Let’s not overlook the fact that this method incorporates a high level of accuracy in your budget, that cannot be realized by just tweaking your previous budget.
This method is also useful for people who do not have regular income. Rather than using a previous month budget template which may be built on a different income amount, you can tailor your budget each month on the expected income for that month. It gives you more control over your budget as you get to build it from ground up.
This method is great for achieving your financial goals. Let’s say you want to save for a car, with zero-based budgeting once you have taken care of your fixed expenses you can decide to forgo other discretionary spend and allocate the remaining amount towards saving for a new car, for example. If you are trying to pay off debt, then you know exactly how much you have left towards paying down your debt after allocating your fixed expenses.
What is the Verdict?
So, is this method a waste of time? In my opinion, absolutely not, as the advantages of this method far outweigh the disadvantages. It pays to take time to evaluate expenditure in greater detail as required under zero-base budgeting.