Non-essential expenses, or those that can be cut down without impacting day-to-day activities, are referred to as being discretionary expenses.
What do discretionary expenses mean?
A company may reduce or even eliminate its advertisement expenditure and not experience an immediate decline in sales. Similarly, if an individual eats out only once a month instead of every week, it would lead to a reduction in discretionary expenses. This would probably not hurt this person’s quality of life.
Now let us consider discretionary expenses in the context of a business organization. There could be times when a company could face severe cash constraints. This could be caused by increased competition leading to a decline in sales. A B2B firm could see its receivable levels rising if a few large credit customers delayed payments. In certain situations, the cash crunch could be so acute that it could threaten the very survival of the company.
What could a business organization do in such circumstances? One obvious step that it could take would be to reduce its expenditure. But certain purchases would remain essential for its survival. For example, it would have to continue buying the raw materials that are needed for producing the goods that it manufactures. It would also have to pay wages and utility bills.
However, the company could slash its discretionary expenditure. The amount spent on employee training programs or, say, office maintenance and repairs could be reduced or even eliminated without hurting the firm’s immediate prospects.
Example of discretionary expenses
Elizabeth Warren, an American politician and academic, has proposed the “50-30-20 rule.” This is essentially a spending/saving plan for individuals to adopt. She says that personal finances can be brought under control by:
⇨ Spending 50% of monthly income on essentials like groceries and rent.
⇨ Spending 30% on discretionary items like eating out, the movies, and hobbies.
⇨ Saving 20% of the amount that is earned.
Ms. Warren points out that following a disciplined approach that recognizes the difference between essential spending and discretionary spending can be the key to living within your means.
A discretionary expense is a cost that can be eliminated without affecting a company’s short-term performance. Businesses reduce discretionary expenses when they are going through a lean period and are trying to conserve cash.