What Is a Discretionary Expense?
The term discretionary expense refers to a cost that a business or household can get by without, if necessary. Discretionary expenses are often defined as nonessential spending or, in other words, wants rather than needs. This means a business or household is still able to run even if all discretionary consumer spending stops. Meals at restaurants and entertainment costs are examples of discretionary expenses.
- A discretionary expense is a cost that is not essential for the operation of a home or a business.
- In a corporate environment, discretionary expenses are usually costs linked with improving a company’s standing with its customers and employees.
- Tracking discretionary expenses enables businesses and households to identify where they can save money in times of financial difficulties.
- Discretionary expenses vary depending on the business or person.
Understanding Discretionary Expenses
Expenses are divided into several categories, namely non-discretionary and discretionary. While non-discretionary expenses are considered mandatory—housing, taxes, debt, groceries—discretionary expenses are any costs incurred above and beyond what is deemed necessary. These are generally considered wants, while non-discretionary expenses are usually referred to as needs. As such, discretionary expenses rarely have anything to do with a business or household's day-to-day operations and, instead, have to do with lifestyle and choice.
Businesses and individuals pay for discretionary expenses with discretionary income or the amount of money left over after paying for housing, food, taxes, and other necessities. When times are good, people have more money to spend, and they normally do so on things they don't need like luxury items and other services—cars, vacations, restaurants, entertainment, electronics.
When times get tougher and short-term cash flow issues emerge, managers and individuals will first look to weed out any unnecessary costs. Discretionary expenses are normally the first to go as stopping them is unlikely to have a major impact on a business or household.
In a corporate environment, discretionary expenses are usually costs linked with promoting or boosting a company’s standing in the market. Buying the raw materials used to produce goods is usually considered essential. Spending less on employee training programs is perhaps less so. Individuals also encounter moments when it is necessary to consider which of their expenses they can live without. A sensible person who runs into financial difficulties is more likely to prioritize paying utility bills over financing a vacation.
What constitutes a discretionary expense is subjective. As such, it may differ considerably among individuals and businesses. For example, a stable, well-established company could probably get away with slashing its advertising budget for a while if the need arises. A new company facing hardship, on the other hand, would probably need to make cutbacks elsewhere, being mindful that boosting exposure and getting its name out there is imperative to keeping it afloat.
The same principle applies to individual consumers as well. Some people may only be able to afford a daily Starbucks run when things are going well. They may consider cutting out this expense when times are tough or if they're saving up for a big expense like a home or car.
Types of Discretionary Expenses
As mentioned above, discretionary expenses are any costs that a consumer or business wants rather than needs. Some common discretionary items include:
- Vacations and travel expenses
- Alcohol and tobacco
- Restaurants and other entertainment-related expenses
- Coffee and specialty beverages
- Hobby and sports-related expenses such as crafting, sewing, and gym memberships
It's important to point out again that what defines a discretionary expense depends on who's doing the buying. For instance, buying a new car may be considered a want for one person, but it may be considered essential for someone who has a long commute to work where driving is the only option.
Discretionary Expenses vs. Non-Discretionary Expenses
Expenses are divided into non-discretionary or discretionary costs. In other words, essential and non-essential ones. Some expenses, such as vacation costs and luxury items, are not necessary to maintain a household and, thus, are classified as discretionary expenses. In other words, the income-earner can pay for these goods or services at his own discretion. Certain expenses, though, must be paid to keep things running such as housing costs, taxes, and health insurance for individuals and payroll, warehousing costs, and transport for businesses. These are considered essential expenses, as the income-earner must pay them on a regular basis or suffer the consequences.
Ranking your discretionary expenses from least to most important can help you identify which costs you need to cut when times get tough.
Advantages of Discretionary Expenses
In tough economic times, it may be necessary for households and businesses to cut back on certain expenditures in response to decreases in income. That's why it's a good idea to track discretionary expenses separately from essential ones so that it is easy to see how costs can be reduced. One helpful budgeting tactic is to rank discretionary expenses in order of importance from the least to most important. If a job loss or income reduction forces budget cuts, household members or a company's management team can easily identify the first discretionary expense to place on the chopping block.