What Is an Inflexible Expense?
An inflexible expense is one that cannot be adjusted or eliminated by a company or individual. It is often the result of a contractual obligation or a long-term obligation that can not be easily adjusted or discontinued. Inflexible expenses are often called fixed expenses.
- An inflexible expense is a cost to an individual or a company that can not easily be changed in amount or avoided.
- Examples of inflexible expenses for an individual include mortgages, car payments, and student loans.
- Companies pay inflexible expenses such as leases, interest, insurance, and salaries.
- Inflexible expenses are generally fixed over a relevant range, a level of activity that only results in additional costs should the individual or company jump to a different relevant range.
- Inflexible costs are considered riskier than other types of expenses. For this reason, lenders may be skeptical to extend credit for borrowers who have too many inflexible expenses.
Understanding Inflexible Expenses
An inflexible expense is a recurring required payment or debt. It likely is a fixed amount whose payment stream is unalterable. For an individual, a typical inflexible expense would be a mortgage, car payments, alimony, or child support, which have fixed repayment schedules by amount and date. For companies, interest, rent, and insurance are inflexible expenses. Salaries are also considered an inflexible expense, though only if the employee is paid independently of hours worked or units produced.
It is important to distinguish which expenses are inflexible. For individuals, these types of costs may prevent them from taking out personal loans. For companies, these types of costs increase operational risk.
The risk behind inflexible expenses is the entity incurring the cost must pay the expense regarding supporting income. An individual must still pay inflexible expenses such as car payments or mortgages should they lose their job. Households should be mindful of which expenses are inflexible, how the loss of income will impact their ability to cover these costs, and how long emergency savings may last considering inflexible expenses.
Alternatively, a company must still pay inflexible costs regardless of business operations. On one hand, companies can use inflexible costs to leverage growth. Agreeing to inflexible contracts allows a company to lock into favorable rates today and remain with those rates as the company grows. However, should company profits falter, the company will be forced to make payments using smaller than expected proceeds.
A cost can be inflexible, flexible, or a combination of both. For example, consider the cost a company pays to a salaried salesperson. Their salary may be inflexible and guaranteed, while the commission may scale with sales and be flexible.
Inflexible vs. Flexible Expenses
A flexible expense is easily altered or avoided. Flexible expenses are costs that can be adjusted by the amount or eliminated by the consumer.
In personal finance, flexible expenses are costs that are easily changed, reduced, or eliminated. For example, entertainment and clothing are flexible expenses. Even necessary expenses, such as groceries, can be considered flexible because the consumer adjusts the amount spent.
A company often makes use of flexible expenses to scale costs based on business needs. Consider a manufacturing company that only buys materials when it needs to produce more goods. Should the company want to manufacture one additional unit, it pays hourly workers the time to make the good and only buys enough materials to make that unit. The company can easily decide to forgo manufacturing that additional unit. Though the company may lose potential revenue, it can elect to avoid the flexible expenses.
In general, flexible expenses are safer for both individuals and companies. However, they may be more expensive as the consumer pays a premium for the flexibility. For example, imagine a subscription service. The service is often priced to be more expensive should the client elect to pay month-to-month. If the client agrees to a long-term plan (i.e. an annual contract), the client gets a pricing discount but loses flexibility.
The entity has discretion of when these types of expenses are incurred.
There is less opportunity to leverage flexible costs and capitalize on scale of economy.
There is less risk associated with flexible costs.
Flexible costs are harder to budget for.
The entity does not have discretion of when these types of expenses are incurred.
There is greater opportunity to leverage inflexible costs and capitalize on scale of economy.
There is more risk associated with inflexible costs.
Inflexible costs are easier to budget for.
For companies, the concept of inflexible and flexible costs is a managerial accounting concept. Both types of costs are accounting for similarly for external reporting and Generally Accepted Accounting Principles. These two types of costs are most useful for making strategic operational decisions and performing internal financial planning.
Inflexible costs often exist within a relevant range. A relevant range is a specific activity level that dictates a specific level of service. Should an individual or company shift to a different relevant range, the inflexible cost will change.
For example, imagine a company pays rent on a 10,000-square-foot warehouse. The company pays $1,000 per month. This rent is an inflexible cost, but if the company should need to double the size of its warehouse, the company's square footage relevant range will increase. Therefore, the company's inflexible expense will increase to $1,600 per month, the market rate for 20,000 square feet.
The relevant range also increases based on the number of underlying variables. Imagine an individual has a monthly car payment of roughly $300. Should the individual decide to buy a second car, the relevant range has doubled, and the individual now has two car payments of $300. Should the relevant range increase again, the individual now owns three cars and must pay ~$900/month.
When displayed on a graph, a relevant range usually looks like a staircase. As long a spender remains on the current step, its inflexible cost will stay the same. If a spender changes the step they are on, their inflexible cost may increase or decrease.
Inflexible expenses are one of several criteria considered by lenders in granting personal loans, mortgages or auto loans. Personal loans are not secured by collateral, unlike a mortgage or car loan, so eligibility criteria are stricter. Lenders closely examine current sources of income and monthly expenses.
Even if the applicant has strong earnings, lenders measure debt by evaluating the amount on credit cards as well as inflexible expenses. The debt-to-income ratio (DTI) equals total monthly debt payments divided by gross monthly income. A lender analyzes both the back-end ratio to analyze inflexible costs excluding housing costs as well as the front-end ratio to analyze inflexible costs including housing costs.
For example, a borrower with $6,000 in monthly income and $2,000 in monthly debt payments has a DTI ratio of 33 percent. Lenders look for a DTI ratio of no more than 43 percent, which is the maximum mortgage lenders allow applicants to have. If an individual has too many inflexible expenses, they will not qualify for a home loan if their income is not high enough.
What Is an Example of an Inflexible Expense?
An inflexible cost is an expense that does not change within a relevant range. For an individual, inflexible costs include car payments, mortgages, fixed loan payments, and installment plan payments on credit cards. For a company, inflexible costs include rent, insurance, leases, and salaries.
What Is the Difference Between an Inflexible Cost and Flexible Cost?
An inflexible cost can not be avoided in the short-term, while a flexible cost is at the discretion of the spender. An individual can choose to not buy new clothes (assuming they are not a necessity), but it can not avoid its monthly obligatory car payment.
Is an Inflexible Cost Risky?
Inflexible costs are often considered riskier than flexible costs. These obligations are required without consideration of the entity's ability to pay or income stability. For example, an individual owes its monthly car payment regardless of its income doubled last month or if it was laid off. Inflexible costs can be used to leverage growth and lock in low pricing, though it leaves the debtor at-risk should they loose income.