Zero-based budgeting encourages you to use all of your monthly income for specific purposes. That doesn’t mean that you get to go on a shopping spree every time you get a paycheck. It simply dictates that all of your money gets allocated to a specific purpose. That means you will manage your savings, expenses, and debt payments so that your income subtracted by your expenditures always equals zero.
It is up to you to label expense categories. You can repeat some of them, change your monthly contribution amounts, and mix things up in whatever way is necessary. When you come under budget in a specific category at the end of the month, then you add the remaining amount to the next budget or send it to an emergency fund.
If you grew up using the envelope system as a way to save your allowance, then this method will feel very familiar.
Several advantages and disadvantages of zero-based budgeting are worth taking into consideration.
List of the Advantages of Zero-Based Budgeting
1. It keeps you aware of your cash flows.
When you are using a zero-based budget, then you are entirely aware of how much money is going into and out of your accounts each month. This method makes it easier to stop spending on credit – which is money that you don’t really have at the moment. If you aren’t tracking where your cash is going each month or it feels like your spending is out of control, then this option can get you back into a better place of financial security.
2. You can customize the budget to fit your specific needs.
If you are new to managing money or have specific needs to meet each month, then zero-based budgeting gives you a way to handle your expenses effectively. You can add or subtract line-item needs each month so that you always know where your cash is going. This recognition makes it easier to find places where you could cut back on your expenses so that you can establish an emergency fund, save for a vacation, or pay for the costs of youth sports.
This advantage makes it a lot easier to keep corporate legacy expenses in check. Traditional budgeting might not examine this issue for several years, waiting until an economic shock disrupts the system. Since costs tend to grow over time, teams cut budgets instead of looking at costs. When done correctly, the zero-based budgeting avoids issues with myopic views.
3. It looks at the reasons why you are spending money.
Traditional budgeting processes look at how much you are spending every time an expense occurs. The zero-based budgeting method also takes into account the reasons why you make spending decisions. It looks at the root of each choice that you make, steering you toward specific objectives – even at an organizational level. Instead of looking at what you accomplished in the past, it ignores your previous habits to focus on the present.
The goal is to correct any spending behaviors that rob your financial health of its full potential. Once that work gets done, then you can manage the rest of your budget. A good approach to take is to spend 50% of your budget on needs, 30% on your wants, and 20% on debt. How you would classify a mortgage (needs vs. debt) depends on what you hope to accomplish with your efforts.
4. It shows places for improvement each month.
The preparation of zero-based budgeting comes with the same assumption that a base from a previous period isn’t required. Self-employed individuals may make an exception to this advantage if their income is variable. You’ll then analyze expenses for the month, quarter, or year to ensure that every spending habit comes from a necessary place and provides a tangible benefit in some way.
5. Zero-based budgeting can discontinue obsolete processes.
The zero-based budget seeks to find inefficiencies in your financial systems by eliminating anything that isn’t useful to your overall monetary health. That means any obsolete process from a personal or commercial standpoint will get found and removed so that you’re not spending on things that you’re not using. It’s like the idea of having four streaming services, but you’re only using one of them each month. This budget would have you eliminate the three that you don’t use.
When you can discontinue obsolete processes, then businesses achieving better costing and pricing. That means more profitability within the organization. If you can achieve a similar outcome with your personal finances, then it is possible to establish a savings account that actually starts to grow.
6. It quickly detects inflated budgets.
If you have too much money in a specific line item in your budget, then the zero-based budgeting method will detect the issue quickly. It looks at the exact amount that you need for a specific review period with the expectation that you run out of money there. When you have a remaining balance, then this indicates that other areas of your finances need more attention.
If you run out of cash there, then it can indicate a problematic area in your spending that also requires attention.
7. This budget can identify opportunities for outsourcing.
The zero-based budgeting approach looks at cost-savings opportunities from a variety of perspectives. If you can save money without sacrificing the quality of your needs or wants, then it can highlight places where outsourcing might be possible. If you look at this advantage from a residential standpoint, then it might suggest moving from a full-time housekeeper to a cleaning service that works on a contracted basis.
Companies often use the zero-based budgeting method to identify over-staffed areas since labor costs tend to be the largest expenditure faced.
8. Zero-based budgeting creates a need to justify each expenditure.
Whether it is a need or a want, the zero-based budgeting method forces people to make choices about their spending habits. You must have a specific reason for every purchase that you make. If there isn’t a valid justification to pursue something, then this approach suggests that you shouldn’t change your cash flows.
That’s why this method facilitates an effective delegation of authority, especially from a corporate viewpoint. Instead of having money move unpredictably based on dozens of different perspectives, you can have one group or team in control of the decisions. Families can take a similar approach where one person manages a majority of the financial decisions.
9. It encourages more initiative and responsibility.
Today’s money isn’t always tangible money. Most people use a cashless approach to their spending because of its simplicity. Why try to manage cash when you can just swipe a debit card that takes what you owe out of your checking account?
The zero-based budgeting encourages initiative and responsibility because you must work with the numbers and physical cash. You must communicate and collaborate across your family or a company so that your spending gets coordinated. That makes it much easier to identify what your high impact costs are versus the ones that have a low or medium impact.
10. You are always in total control of the budget.
Every dollar has a job when you’re using the zero-based budgeting method. That’s why it controls mindless spending effectively. When you know where your cash flows need to go each month, then it’s easier to understand what you need to do. If you need to change something, then you can always move a few dollars here and there to create a new line item. It familiarizes you with your accounts, spending habits, and money handling abilities.
List of the Disadvantages of Zero-Based Budgeting
1. It takes a lot of time to manage a zero-based budget.
If you are going to hold yourself accountable to your overall budget, then you must closely monitor your spending every month. Because every household faces a set of variable expenses, it can be a challenge to create this structure if you’re new to budgeting. You must account for irregular costs every month or this approach can leave you without enough money to take care of everything.
You’ll want to set money aside for these costs through a savings fund that becomes part of your “needs” category. It must be separate from your emergency fund, retirement goals, and other savings measures and receive monthly contributions.
2. Having an unpredictable income can make this budgeting method impossible to use.
The zero-based budgeting method works best when you have predictable monthly income levels. If you work as a freelancer, in the gig economy, or as an independent contractor, then you never know how much money to allocate each month. Even hourly workers with fluctuating schedules can encounter this disadvantage. You can use the income from the previous month as a budget for the next one, but that also means having the ability to have a month’s worth of income as a savings buffer to maintain the budget.
3. A zero-based budget has more subjectivity in the decision-making process.
Some of your expenses can be challenging to classify as a need or a want. How you decide things are essential is based on your personal perspective. There are qualitative considerations where value goes beyond the cash that you’ve got available, which means numbers, needs, and wants can’t be your only points of reference.
What if you go to a massage therapist twice per month for migraines? How do you classify Christmas presents in your budget? One family might perceive youth sports as a need, while another could see it in the “want” category. There is no consistency, and that means the achievable results can be highly variable.
4. It could be detrimental to your long-term financial goals.
The zero-based budgeting method looks at a cost-benefit analysis in the present time. That means you’re accounting for all of the cash flows in a specific snapshot. You’re not looking toward the future or reliving the past. That means an expense that could feel like a long-term need is seen in the present tense as a short-term want.
Imagine that you have about $50 extra per month. Your child wants to participate in soccer, which is an optional expense. The zero-based budgeting method might suggest that you avoid that cost, but then what happens if that stops your child from earning a scholarship? Long-term investments are not always a priority.
5. Zero-based budgeting may have some flexibility, but it is also rigid.
The goal of zero-based budgeting is to avoid debt whenever possible. It can be an essential practice that eliminates problems with credit card spending because you’re only using the money that you earn each month. This rigidity can also create problems when you run out of cash in your budget for some reason.
Even if you have an emergency fund and a separate area of expenses for unusual charges, there can be incidents that overwhelm your finances for the month. The rigidity of this approach dictates that you take money from other places, which eventually means something gets sacrificed.
6. It requires financial skills to implement.
Conflicts can arise when taking the zero-based budgeting approach because it requires a significant amount of skill and time to implement. If that is not available within a household, then there isn’t a way to implement this method successfully. You can always take time to learn how to manage finances like this from industry experts, but then that means you’re taking another commitment that you may not have time to manage.
7. Savvy budgeters can manipulate the zero-based process.
People who know how to manipulate the approaches that the zero-based budgeting method encourages can use it to increase resources for themselves or their departments. When this disadvantage occurs in a family, then it can lead to enough discord that can result in a separation or worse. Workplaces that experience this issue often see a change in their culture that includes a decrease in cooperative spirit. It often causes people to feel like their expendable or viewed as a commodity instead of as an individual.
Before you implement a zero-based budget for the first time, you will want to take a few steps to ensure that you are taking a realistic approach to your spending.
It starts by knowing your income. You need to total your paycheck, child support, alimony, and any other source of income to know how much you have.
Then track your expenses for a few months. When you have an idea of what you typically spend and where you shop, then you’ll have a data framework that works well for your budget. Then you can quickly spot some areas where you can cut back on your spending habits.
The final step is to categorize your expenses. You must be honest to a fault with your definition of needs vs. wants to have this be a successful experience. Then you can evaluate the advantages and disadvantages of zero-based budgeting through an authentic lens to see if this option is beneficial for your financial needs.
Blog Post Author Credentials
Louise Gaille is the author of this post. She received her B.A. in Economics from the University of Washington. In addition to being a seasoned writer, Louise has almost a decade of experience in Banking and Finance. If you have any suggestions on how to make this post better, then go here to contact our team.