What is a discretionary expense?
A discretionary expense is a cost that a business or household can do without, if necessary. These expenses are often defined as things that are “wants” rather than “needs”. For example, a business may allow its employees to charge the business for certain meals and entertainment. This is done in order to promote goodwill among employees, rather than ensuring the survival of the business.
Key points to remember
- A discretionary expense is a cost that is not essential to the operation of a home or business.
- In a business environment, discretionary spending is usually a cost of improving a business’s position with customers and employees.
- Monitoring discretionary spending allows businesses and households to identify where they can save money in the event of financial difficulties.
- Discretionary spending varies by company or person.
Understanding discretionary spending
When times are tough and cash flow problems arise in the short term, business leaders will first seek to eliminate all costs deemed unnecessary. Discretionary expenses, the costs associated with business activities that are not directly related to operational procedures, will be the first to be implemented, as their cessation should not have an impact on the ability of the business to operate and produce goods.
In a business environment, discretionary spending is usually a cost of promoting or strengthening a business’ position with customers and employees. The purchase of the raw materials used to produce goods will probably be considered essential. Spending less on employee training programs may be less.
Everyday people also encounter times when it is necessary to consider without which their expenses they can live. A sensible person who is experiencing financial difficulties is more likely to prioritize paying utility bills over vacation financing.
Businesses and individuals pay discretionary expenses with discretionary income: the amount of money left over after paying taxes and necessities.
Essential vs. discretionary spending
Households incur two types of expenses. Some expenses they must either pay by law (such as taxes and health insurance) or pay to run the household (such as rent, food and transportation). These expenses are essential expenses, because the employee does not have the possibility of not paying them during a given month without incurring consequences.
Other expenses, such as vacation expenses and luxury items, are not required to maintain a household and are therefore classified as discretionary expenses. In other words, the employee can pay for these goods or services at his discretion.
Benefits of discretionary spending
In difficult economic times, it may be necessary for households and businesses to reduce spending in response to declining incomes. Thus, it is often desirable to track discretionary spending separately from essential spending so that it is easy to see where and to what extent spending can be reduced.
A useful budgeting tactic is to rank discretionary spending in order of importance, from lowest to highest. Therefore, if a job loss or reduced income forces households to cut their budgets, household members can easily identify the first discretionary expense to place on the cutting block.
The concept of what is discretionary is subjective and can differ considerably between individuals and companies.
For example, if needs should, a stable, well-established business could probably get away with cutting its advertising budget for a while. On the other hand, a new company facing difficulties would probably seek to make cuts elsewhere, knowing that it is imperative to strengthen its exposure and make its name known to keep it afloat.