A zero-based budget is designed to help you plan for all expenses--even the unexpected ones--while still having money set aside for entertainment, vacations, retirement and major future purchases, such as a house or car. Spending time on this paper process may seem like overkill in the beginning, but you may realize a zero-based budget helps build money in important areas of your life.
Income Equals Outgo
When most people create a budget, they simply list their regular monthly bills and expenses, subtract them from their income, and possibly make a few adjustments so they'll spend less. Any money that is left over usually is treated as "extra" to use any way they want. A zero-based budget purposely plans to make income equal the outgo. The goal is to allocate every single dollar you have coming in, so that it has a pre-defined "job" to do now or in the future. Once you've finished creating a zero-based budget, you have no negative and no positive balance. Every dollar of your income is assigned and every expense is accounted for.
Plan for Everything
A big part of creating a zero-based budget is trying to plan for everything. Instead of dealing with an emergency when it occurs by shuffling funds from another area of your budget, for example, you assign money to an emergency or unexpected events category on your budget. Part of your income is allocated to this category every month, so when something does come up, you already have money set aside to deal with it. Planning for everything also means taking care of annual and irregular expenses in advance. With a zero-based budget, you may set aside $50 a month, so that when it's time to pay the semi-annual $300 car insurance bill you have it covered. Likewise, you set aside something each month toward holiday gifts, taxes or new eyeglasses. Everything you spend is accounted for in a zero-based budget, and money is set aside regularly to cover each expense as it comes due.
Assign All Funds
Because your income must equal your expenses in a zero-based budget, and you must plan for everything that might come up in your life, you have to assign every dollar somewhere each month. The goal is to have no money that isn't allocated to something, while not having expenses total more than your monthly income.
Spend On Paper
A zero-based budget essentially obligates you to spend all your money on paper in the form of a spending plan before you receive it. First, add up all take-home pay and regularly received income. This is the basis of your monthly budget. List each fixed expense and subtract it from the income total. List savings and emergency funds, and assign a portion of your income to each and subtract those. Next, list all irregular, semi-annual and annual expenses, such as car registration or property insurance, and break the payments down into monthly amounts. Subtract each of those from the remaining monthly income. Subtract variable expenses such as food and transportation costs next, estimating how much is needed each month. Use previous receipts and bank statements to help adjust these estimates in the beginning. Remaining funds should be distributed among miscellaneous areas such as holiday gifts and pocket change, or they can be used to adjust existing categories that were budgeted too low. List any special goals, such as a vacation or a car purchase, and allocate funds to that each month.