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What is Zero Based Budgeting, and How does it Work?

Posted by Tom Hallissey on Jan 30, 2019 10:00:00 AM

zero based budgeting

Your most important job is balancing the books. The success of your business depends on it. To achieve this crucial goal, every company needs a strategy. Although there are several options available, many business leaders swear by the power of zero based budgeting.

What is Zero Based Budgeting?

Zero based budgeting is a cost management method in which all expenses must be justified in each accounting period. The budget starts from zero and every part of an organization is analyzed to determine its needs and costs. Also known as a zero sum budget, it intends to assign a purpose to every single dollar.

The goal is that your income minus your expenditures equals zero at month’s end. This popular method is a proactive way to contain costs.

The Pros

A zero based budget is advantageous, because it tracks how much money flows in and out of your organization. It can help prevent you from spending money your business does not have.

The Cons

Zero based budgeting tends to be very time consuming. You must be able to closely and consistently monitor your spending.

zero based budgeting

How to Start a Zero Based budget

Zero based budgeting begins with the assumption that all department budgets begin at zero and must be rebuilt from there. As a result, every expense in every department must be justified before being approved.

1)      Know your Income

The first step is to figure out exactly how much money your business has to work with. Tally all the different types of income you are receiving in a given month. This will give you a picture of your company’s overall financial health.

2)      Track your Expenses

Next, find out how much money is leaving your hands every month. This figure could include expenses like payroll, office space or product materials.

zero based budgeting

3)      Create Categories

Then, take all this data and categorize your cash flow. Identify your obligations, needs, wants and goals. For example, are you planning to increase the size of your payroll this year? You could then make a category to fund this goal.

4)      The 50/30/20 Rule

After categorizing your expenses, financial professionals recommend that you apply the 50/30/20 rule: 50 percent of your income goes to your needs; 30 percent towards your wants; and 20 percent to debt repayment and savings.

Zero Based Budgeting vs. Traditional Budgeting

Zero based budgets are more stringent than other types of money management methods. Traditional budgeting calls for two percent yearly incremental increases in spending. However, zero based budgeting starts from scratch every time.

Another key difference is that zero based budgets analyze not only new expenditures but also calls for the justification of old, recurring expenses. This more comprehensive approach works to find the value in all parts of an organization.

Whether you use a zero based budget or a traditional one, you will benefit from developing a strategic plan first. If you have questions about financial management or need help getting started with budgeting, contact your local tax professional.

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Topics: Business Accounting

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