How much of your company’s spending is absolutely, unequivocally necessary?
Or, put another way, what percentage of your current business spending could you survive without?
In financial accounting, this is known as discretionary spending, that which is not 100% essential to the company’s ongoing operations.
Having a strong understanding of what discretionary expenditure is and looks like is an important step toward improving spend management and lifting profitability.
In this article, we’re going to give you a quick 101 on discretionary expenses. We’ll discuss what they are, provide common examples, and dive into some important strategies that you can implement right now to more effectively manage discretionary spending.
What is a discretionary expense?
A discretionary expense is any business expense that isn’t vital to the ongoing operations of your company.
Your electricity bill, for example, is not a discretionary expense. If you don’t pay it, you won’t have any power at the office, and your team won’t be able to do any work.
Client gifts, on the other hand, are a discretionary expense.
While they might be important to ongoing client relationships, your business can still keep on going without providing annual holiday gifts.
Understanding discretionary expenses
Business spending can be divided into two broad categories: discretionary and non-discretionary.
Non-discretionary spending can also be called essential expenses, with discretionary expenses being considered non-essential spending.
Non-discretionary expenses, simply put, are mandatory for a business to operate. Expenses like taxes, debt repayments, and wages fall into this category.
Discretionary expenses rarely have anything to do with a company’s day-to-day operations, though they may be important for making the business more successful.
Many marketing activities, for instance, can be considered discretionary expenses. They are not vital to the ongoing operations of the business, even though they can help to improve its standing and capture more market share.
It’s important to understand what categories your different business expenses fall into, as it can help you create more effective budgets, especially during downturns.
When economic conditions change for the worse or cash flow becomes tight, discretionary expenses are the first you’ll want to start cutting.
Examples of discretionary expenses
On first thought, you’re probably imagining that most, if not all, of your company’s spending is vital.
However, a surprising number of expenses fall into the discretionary expense bucket. Here are a few of the most common types of discretionary expenses:
- Employee training and development. The costs of workshops, courses, and seminars that improve employee skills are valuable but not essential.
- Marketing and advertising. Most marketing and advertising activities are not operationally necessary. Unless 100% of your company revenue comes from the marketing campaigns you’re running, this is not a necessary expense and can, therefore, be considered discretionary.
- Travel and entertainment. Business trips, conference attendances, client dinners, and team-building days are not crucial to operations.
- Office renovation or upgrades. This is generally considered discretionary spending unless your business could not continue to operate without the renovation being completed (such as necessary repairs after a natural disaster).
- Gifts and incentives. Recognition rewards for employees or client gifts are discretionary expenses, as are bonuses that your company is not contractually obligated to pay.
- Corporate Social Responsibility (CSR) initiatives: Event sponsorship, charity donations, and other community involvement are generally not considered vital.
- Subscriptions and memberships. Magazine and club subscriptions and fees for networking groups and professional associations are most often discretionary expenses.
Discretionary expenses vs. non-discretionary expenses
A discretionary expense is any business spending that is not strictly necessary for that company to operate.
The cost of a lunch meeting for a manager-employee performance review is an example. Even though the performance review is important to the company and for the employee’s ongoing development, the company would continue operating if the lunch did not take place.
A non-discretionary expense is any business expense that the organization must bear in order to continue operating. This includes costs such as rent, wages, utility bills, and cost of goods sold.
Discretionary expenses vs. fixed expenses
Discretionary expenses are business expenses that are not absolutely vital to the ongoing operations of a company, such as the purchase of new artwork for the office.
Fixed expenses are costs that a company pays the same amount for, regardless of changes in production level. That is, the price does not change if the business does well or if it has a slow month.
Many fixed expenses are non-discretionary expenses. That is, they are vital to the company’s ongoing operations.
Salaries are a good example. The business has to pay salaries to its employees in order to operate, and the amount it pays is fixed contractually.
This is not always the case, however.
Consider a company that pays for an annual subscription to a learning resource, like HBR or Medium.
That’s a fixed cost, as the monthly subscription stays the same regardless of how well the company does. The company would continue to operate without it, however, so it's also a discretionary expense.
What is the 50 30 20 rule?
The 50 30 20 rule is a helpful method often used for personal budgeting.
The idea is that you split your income like this:
- 50% on needs
- 30% on wants
- 20% on savings
Businesses can apply a similar method, putting aside 50% for necessary spending, 30% for discretionary spending, and 20% saved for future investments.
What are discretionary funds?
Discretionary funds are the funds your business keeps aside for discretionary spending. That is, it's the cash you have saved on non-essential expenditures, such as shouting pizza for your team at the end of a strenuous but successful project.
Strategies for effective management of discretionary expenses
Now that you’ve got a good idea of what discretionary expenses are and how they impact profitability and financial success let’s turn our attention to some strategies to manage them more effectively.
1. Align discretionary spending with business goals
Just because discretionary spending isn’t necessary doesn’t mean it should be used for frivolous or excessive purchases.
Instead, align the discretionary purchases you make with the goals you’ve set for your organization.
For example, if one of your business goals is to improve employee retention, focusing discretionary spending on activities like company retreats or team-building is a valid cost.
2. Measure expense ROI
Then, look for opportunities to measure the impact of that spending.
If you decide to invest in additional team outings, say, you can measure the ROI on that spending by tracking how employee turnover changes and stacking those savings up against the cost of the investment.
3. Increase spend visibility
You can’t very well manage your discretionary spending behaviors if you don’t first have an insight into where, how, and when the spending is happening.
This is called spend visibility.
Improving your spend visibility is a relatively straightforward process, as there are a number of helpful tools around that can provide access to powerful insights.
Take BILL Spend & Expense, for instance.
You can integrate the expense management solution with your other business finance tools, such as your bank account or bookkeeping platform, creating two-way syncs to ensure data is always kept up-to-date in all places.
Then, you can dig into a powerful reporting suite that you can use to design custom dashboards, filter spend by category or department, and even create forecasts to help you budget more accurately for future discretionary expenses.
4. Develop a spend approval process
Since discretionary spending is not something that contributes to the vital ongoing activities the business is engaged in, you might find it reasonable that any expense that falls under the umbrella of “non-essential” be signed off by an appropriate authority.
The best way to put this into practice is with a payment approvals workflow, which is essentially a set of steps that employees must follow to get a given expense request signed off.
Accounts payable automation solutions like BILL can help strip off some of the red tape around the approvals process and make them more efficient with automated approval routing and programmed reminder notifications, helping your team get payments approved 2-3x faster.
Get on top of discretionary spending
Discretionary expenses, while not strictly necessary for the ongoing operations of a company, are a common and important part of business life.
Like most business expenditures, what’s important is that you have strong visibility over your company’s discretionary spending and the ability to put spending controls in place where necessary.
BILL Spend & Expense is the perfect partner for business owners looking to take control of their company financials.
With powerful reporting tools, access to business financing and employee spend cards, and helpful spend control solutions, you’ll improve visibility and control over discretionary spending.
Schedule a demo today to learn more.
