Discretionary Expenses: Definition, Types, and Budgeting

Know the difference between your necessary and discretionary expenses – Alexa Von Tobel

Discretionary expenses are non-essential costs that don’t significantly impact the day-to-day operations of an organization. CFOs and accounting teams track and analyze this non-essential capital expenditure to reduce overall business expenses, boost margins, and improve short-term profitability during a crisis. 

This article walks you through discretionary and non-discretionary expenses, how to budget for them, and ways to balance them with financial goals.

What is a discretionary expense?

A discretionary expense is voluntary spending that isn’t essential for core business operations. Organizations can survive without these non-essential expenses, which is why they are also known as non-essential spending.  

Most organizations spend discretionary costs to improve their reputation and customer and employee relationships. Common examples include expenses related to research and development, employee benefits, office improvement, and training. 

Discretionary expenses are born out of wants, whereas non-discretionary expenses arise from needs. Companies typically pay for these spending with discretionary income, the amount of money they have left after paying for necessities, including rent and tax. Tracking discretionary costs aids organizations in identifying and cutting unnecessary expenses during financial difficulties.

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Importance of discretionary expenses

Keeping an eye on discretionary expenses enables business leaders to improve cash flow, maintain profitability, mitigate financial risks, and optimize resources for the long-term economic sustainability of their organizations. 

• Improved cash flow: Organizations tracking discretionary can quickly cut costs and reallocate that budget to revenue-generating activities. Analyzing discretionary spending patterns also enables them to avoid overspending and create emergency funds for economically turbulent situations. 
• Business profitability: Lowering discretionary business expenses allows organizations to offer competitive prices, reduce waste, and boost operational efficiency — all key to improving profit margins.
• Reduced financial risks: Businesses controlling discretionary cash outflow can free up funds for meeting financial obligations, paying interests, and reducing the cost of debt. They can also use the savings from reduced discretionary costs to create financial reserves, which can help them avoid liquidity crises during revenue shortfalls and market fluctuations.
• Strategic growth: Efficient discretionary cost management is also essential for efficient financial management and resource allocation to strategic areas such as marketing or employee training.

Now, let’s look at the different discretionary costs in business.

Types of discretionary expenses

While discretionary expenses are unique to every business depending on their industry and nature of work, here are some common discretionary items. 

• Marketing expenses: While the budget may vary, most companies spend quarterly on paid ads, inbound marketing, content production, public relations, brand design, and website design. These marketing activities are discretionary as an organization still offers its core services without them. 

• Investments: Business investments like mergers, buyouts, real estate, and research and development may help organizations increase profits but are discretionary. 

• Non-essential SaaS subscriptions: Enterprises use multiple tools for daily operations, including but not limited to project management tools, accounting software, and expense management software. An organization may use these solutions to boost ROI but can control how much they spend for them.

• Employee perks and benefits: Some organizations may offer employee perks (transport, gym memberships, fitness passes, pantry) or conduct team-building exercises. While these perks may be crucial for talent retention, companies can control how much they spend. 

• Business travel expenses: Large enterprises may offer generous T&E expenses for their traveling employees and sales teams, whereas smaller organizations may not be able to provide the same. The fact that organizations can regulate this spending with T&E policy makes it discretionary.  

• Office and workspace upgrades: Companies investing in workspace design and layouts can moderate the amount they spend toward these upgrades, making workspace enhancement expenses discretionary. 
• Professional training and development: Some organizations conduct workshops, offer online courses, and other professional development initiatives. These expenses are discretionary as they aren’t necessary for day-to-day operations.

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Discretionary costs examples

Examples of these expenses include:

• Marketing and advertising 
• Employee training and development
• Business travel and entertainment
• Research and development
• Charitable contributions
• Employee perks and benefits
• Office upgrades and renovations
• Software technology investments

Now, let’s understand how these expenses differ from non-discretionary business spending.

Discretionary vs non-discretionary expenses

Discretionary expenses are non-essential spending, whereas non-discretionary spending is unavoidable capital expenditures necessary for business operations.

Non-discretionary expenses are fundamental costs an organization must pay to run daily operations, regardless of financial performance. Companies can’t quickly eliminate these costs as they are rigid and don’t change in the short run. Examples of non-discretionary spending include:

• Employee salaries, benefits, and retirement contributions.
• Utility costs for essential services like water, heating, and electricity.
• Rent for office spaces, manufacturing units, and production equipment.
• Premiums for property insurance, liability insurance, and workers’ compensation insurance.
• Income and property taxes payable to government regulations.

Suggested Reads: Non-operating Expenses

Aspect	Discretionary expenses	Non-discretionary expenses
Nature	These expenses are optional, and businesses can eliminate them when needed.	Organizations can’t avoid these essential expenses necessary for daily operations.
Flexibility	Discretionary spending is highly flexible.	Non-discretionary costs aren’t flexible and remain fixed over a period.
Management control	A company has complete discretion in increasing or decreasing these expenses.	An organization may need to negotiate with vendors or make contractual changes to curtail non-discretionary spending.
Operational impact	Lowering discretionary costs may help a company improve short-term profitability and cash flow.	Curtailing non-discretionary expenses may affect an organization’s operations significantly.
Financial statement	Discretionary expenses appear as non-essential operating expenses under variable costs.	Non-discretionary costs appear under fixed operating costs in financial statements.

Fixed expenses vs discretionary expenses

Fixed expenses refer to fixed business costs that don’t change with production outputs or business activity levels. Businesses must pay these fixed costs to remain operational. Examples include phone service, utility bills, interest payments, property tax, and employee salaries. 

Discretionary expenses are non-essential costs that a business spends at its discretion. These costs have no bearing on the daily operations of an organization. Examples include expenses related to training and development, marketing, employee benefits, and software subscriptions. 

Aspect	Fixed expenses	Discretionary expenses
Nature	These expenses are contractual and remain unchanged over the short run.	Organizations can eliminate discretionary spending based on situations.
Necessity	Fixed costs are essential for maintaining business continuity.	Discretionary expenses are optional and don’t impact business operations.
Predictability	Fixed expenses are highly predictable, making it easier for organizations to create budgets.	Discretionary costs aren’t as predictable and can change depending on management decisions or market conditions.
Profitability	Fixed business expenses impact profitability significantly when they constitute a more significant part of the total cost structure.	Depending on their priorities, businesses can increase or decrease discretionary costs to lower or boost profits.

How to balance discretionary expenses with financial goals

Companies struggling to control discretionary expenses must start by creating short-term and long-term goals. The next step for them is to optimize discretionary spending, repay debts, and prioritize savings to achieve their goals.

• Set short and long-term financial goals: Setting financial goals is the foundation of robust financial planning. These goals provide organizations with clarity around how much discretionary spending they should allocate and when they should optimize discretionary expenses. 

• Adjust discretionary spending: The next step is to evaluate discretionary spending patterns. Based on that analysis, an organization can find areas to curtail spend and reallocate those funds to revenue-generating business areas. 

• Repay debt: Organizations should also consider repaying debts with high-interest rates faster or consolidating them to put aside funds for emergencies or invest in other high-growth areas.  

Now, let’s look at how companies can budget for discretionary expenses.

What is discretionary expense budgeting?

Discretionary expense budgeting refers to using financial systems for tracking and optimizing discretionary spending. It enables organizations to gather intelligence on how discretionary spending varies throughout the year.

How to budget for discretionary expenses

Organizations looking to excel at discretionary expense budgeting must focus on measuring expense ROI, categorizing discretionary spending trends, and creating and enforcing an expense management policy.

• Find qualitative or quantitative ways to measure expense ROI: Organizations spending on expenses don’t always receive the return on investment they expect. For example, an enterprise may spend thousands of rupees on a new SaaS tool subscription. Still, employees may not find the tool helpful. The result is wasted spending. That’s why it’s essential to measure the ROI of every recurring expense qualitatively or quantitatively. 

• Track discretionary expense trends: Businesses must track expenses to understand where they spend the most across categories, discover seasonal patterns, and reduce overspending. These insights are crucial for identifying problem areas and improving efficiency. Moreover, companies can also use historical data to predict future costs better. 

• Design and enforce expense policies: Well-defined expense policies set department-specific and category-specific spending limits based on discussion with relevant stakeholders. Implementing these policies enables companies to calculate margins even for the worst-case scenarios. Organizations also must automate expense approval so employees can focus on value-added tasks.  

• Create expense review processes: Regularly reviewing discretionary spending enables enterprises to optimize areas with high expenses and improve financial performance. 

• Create a cash margin of reserve: Most organizations put discretionary expenses under scrutiny after experiencing financial turbulence. That’s when they drastically cut costs, negatively impacting employee morale and vendor relationships. Creating a six-month cash margin of safety enables them to scale cost-cutting slowly without interrupting existing workflows.

While most businesses turn to cutting discretionary costs during a financial crisis, they can also use it for their strategic advantage; let’s see how.

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Cutting discretionary costs during a financial crisis

Organizations cutting discretionary costs during a financial crisis must adopt a tactical financial strategy while balancing long-term vision. They must opt for a phased approach after considering the impact of each reduction. 

• List discretionary expenses: The first step involves finding existing discretionary costs and areas where an organization can reduce expenses without impacting daily operations.

• Impact assessment: Next, they must evaluate whether cutting expenses aids them in achieving business needs and goals in the short and long run. 

• Stakeholder collaboration: Organizations must ensure cross-departmental collaboration to prevent unintended consequences as the phased discretionary cost reduction begins. 

• Real-time monitoring: Companies should also use expense reporting tools to monitor the effects of cost-cutting and make necessary adjustments. 

When used right, discretionary expenses enable businesses to capture new opportunities and make strategic choices that translate into future success. At the end of the financial crisis, organizations rank discretionary expenses based on their ROI to meet business objectives.

Strategies for reducing discretionary expenses

Now, let’s go over strategies organizations can deploy to reduce discretionary spending. 

• Establish a strategic budget: A comprehensive business budget is essential for identifying which discretionary and non-discretionary expenses an organization can curtail. They should also prioritize financial goals by setting spending limits. 

• Assess spending periodically: Reviewing spending patterns at regular intervals can aid organizations in controlling finances and avoiding overspending.

• Negotiate with vendors: Comparing different suppliers and their prices gives businesses significant annual cost savings and a competitive procurement advantage. 

• Implement employee cost-saving initiatives: Organizations should also promote cost-saving behavior among employees. This cost-conscious culture ensures employees pay attention to their spending habits and improve the company’s financial health. 

Let’s look at the tools organizations use for managing discretionary expenses.

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Tools for monitoring discretionary expenses

Using spend management software is essential for businesses to track and manage discretionary costs efficiently. These tools enable finance and accounting teams to spot areas where employees overspend and their spending habits. Moreover, these platforms integrate with ERPs and accounting systems to help organizations gain insights into improving discretionary spending management. Some cloud-based solutions also let organizations set up a requisition approval process to keep costs under control.

Suggested Reads: Best Expense Management Software

Conclusion

All discretionary costs may not be optional for every organization, depending on their industry and the spending category. That’s why companies must set expense policies to analyze, approve, and track discretionary expenses. Using spend management systems helps them keep costs under control and spot savings opportunities.

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