What Are Discretionary Expenses?
Definition: In business, discretionary expenses are costs that cover activities that have insignificant effect on the core business. Such expenses have little effect on the operational procedures of the business if they are reduced or even removed completely. The nature of the expenses is not necessary for proper operation of the business. If it is a household, life can continue smoothly within the family if the household rids itself of discretionary expenses.
Discretionary expenses often form part of a business’ capital expenditure. However, if the business removed the expenses, they are unlikely to experience problems in their short-term profitability. Oftentimes, businesses remove or curtail such expenses when cash flow difficulties set in. However, the removal of the discretionary expenses might begin to have a significant impact on the business if it goes on for a long time.
Households and companies alike have incurred expenses in the course of their operations. However, some expenses are necessary while others are discretionary. The ability to distinguish between the two is crucial for businesses and households to remain functional in good and tough times. Read on to learn more about discretionary expenses.
Business Discretionary Expense Examples
Some of the discretionary expenses for a business include funds set aside to train employees and to maintain equipment. Others include funds set aside for advertisement, research development to improve the product pipeline of the business, funds for quality control, and contributions to employee welfare and so on.
The impact or removing the expenses may begin to register in the long term. For example, removing R&D will affect the ability of the business to innovate and improve the quality of the products and services offered. The same is true if the business curtails expenditure on quality control. Further, if the business stops training employees to help develop their careers, the business might begin to encounter high turnover levels of key employees.
Importance of Discretionary Expenses
While discretionary expenses might come across as needless, they are not. These are costs that businesses incur to optimize their productivity. Businesses usually cut back on discretionary expenses when cash flow is inadequate to fund all operations without any problem. However, it is important to understand discretionary expenses well because the knowledge helps to prioritize the expenses.
Understanding discretionary expenses enables businesses to rank them in order of significance. For example, a business can rank research and development as higher priority discretionary expense than contributions to employee welfare. However, the business can put a much higher priority on quality and equipment maintenance. This ranking achieves two goals. First, it helps business to allocate capital to areas that are more urgent in terms of helping the company to achieve the core business objectives. Second, the ranking facilitates better decision making when it comes to eliminating some expenses to compensate for tightening cash flow.
Further, it is important to understand discretionary expenses such that businesses can track them separately from fixed/necessary expenditures. Separate tracking of the expenses makes it easy to readjust business operations when cash flow difficulties begin to bite. Tracking the discretionary expenses separately helps the business to determine the expenses that are more consequential to the core operations in case of their removal.
Issues associated with the concept of discretionary expenses
A sound business has a clear understanding of its expenses. However, the true nature of discretionary expenses is difficult to place because the concept is subjective. Different businesses view discretionary expenses differently.
For example, an established global conglomerate like Procter & Gamble might easily curtail expenditure on advertisement during a cash crunch. However, such a proposition may be unpalatable to small firm that is still struggling to get exposure. For such a firm, advertising expenditure is not discretionary. Instead, the business might resort to cut expenditure elsewhere.