What are discretionary expenses and why should businesses pay attention to them?
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Modern companies have several types of expenses, some essential and some not. In this article we define discretionary expenses and compare them against non-discretionary expenses, so you know how to deal with them for your business.
What are discretionary expenses?
Discretionary expenses are costs that aren’t necessary for your business operations, while non-discretionary expenses are mandatory spending.
Discretionary expenses are also called non-essential expenses or non-essential spending. However, don’t confuse non-essential for unnecessary or unimportant.
For example, marketing expenses aren’t as essential to your business as operating expenses like rent and utility payments. However, marketing expenses boost revenues and are important for your business to thrive.
Fixed expenses vs. discretionary expenses
Fixed expenses refer to recurring costs that remain relatively constant from period to period, while discretionary expenses are non-essential spending that businesses choose to incur. Since a business’s fixed expenses aren’t always mandatory spending, there’s some overlap between the categories.
Examples of fixed expenses might include rent or mortgage payments, utilities, insurance premiums, loan repayments, and subscriptions. However, with something like subscriptions, this can also be considered a discretionary cost. The subscription is paid monthly, but it isn’t mandatory spending.
Why should you monitor discretionary spending?
You should monitor discretionary spending because these expenses are largely under your control. If you monitor discretionary expenses, you can reduce costs associated with your business and boost net margins. This is why discretionary spending analysis is critical to successful small business expense management.
For example, if you want to boost net margins by five percent over the following year, you can reduce discretionary costs to achieve that goal. Reducing non-discretionary expenses (also called necessary expenses) such as bank interest or utility bill payments is far more challenging.
This is why you must track business expenses and discretionary spending. For instance, you can reduce your marketing budget by allocating less money for ad spending. While your marketing department will not be as prolific as in the past, your business will likely cope with these cost reductions.
Discretionary expenses are subjective
You can figure out which expenses are discretionary and non-discretionary by examining them literally. For instance, the amount of money you devote to research and development is at your discretion. The amount of bank interest you pay is not. In this case, the former is a discretionary expense while the latter is non-discretionary.
Some non-discretionary expenses at one company might be discretionary for another. For example, let’s consider two companies: Company A, a supermarket, and Company B, a remote-first SaaS company.
Company A's rent payments are essential to their survival. Without retail space, A will struggle to sell groceries. However, rent payments are probably non-discretionary for Company B. Its teams work remotely, and the amount of money B devotes to office space is at its discretion.
The lesson here is: Examine how critical an expense is to your company's survival and classify it accordingly. Labels from other companies might not suit yours since your business' economics are unique.
Examples of discretionary expenses
While every company's discretionary expenses are unique, some expense categories tend to fall under the discretionary umbrella more often than not. Here are some examples of discretionary spending with an explanation of why they're so.
Marketing expenses are important for companies of all sizes. However, the amount of money you devote to marketing is at your discretion. For example, you might decide to spend money on paid ads and inbound marketing. Or, you could decide to execute just inbound marketing strategies.
What's more, your strategies might change from one quarter to the next. A growing small business might decide to invest more into paid advertising, given the success of its existing marketing campaigns, for instance.
Here are some types of discretionary items within marketing:
- Content production
- Public relations
- Brand design
- Website design
A successful business might profit immensely by making the right investments. For example, your company might decide to buy a vendor that supplies essential raw materials. This investment will reduce procurement risk in your supply chain.
Like marketing, investments are important but discretionary. Here are some examples of other discretionary expenditures that fall under the investments umbrella:
- Real estate
- Research and development
Every small business uses tools to smooth its workflows. Accounting, invoicing, expense management, and productivity tools are a few examples. While you must invest in these tools to boost your ROI, the amount of money you spend on them is at your discretion.
For example, you could communicate with your team members via pre-recorded videos or an instant messaging tool. These options' costs vary, and you must choose the one that best fits your needs. As a result, the money you spend is in your control.
Some tools might seem indispensable. However, you can still opt for cheaper plans or alternatives, reducing your expenditure. This is why SaaS subscriptions are discretionary.
Perks are essential to attracting top talent to your company, making them the most essential cost on this list. However, you control the amount of money you spend offering perks.
Here are some examples of employee perks:
- Pantry and dining out
- On-site entertainment
- Gym memberships and fitness passes
- Team-building exercises
As with SaaS subscriptions, many of these perks are necessary to retain top talent. However, you can control how much you spend on perks, depending on your priorities.
If your company employs sales teams, then managed travel expenses are a significant expense for your business. Some products need in-person demos to answer prospect concerns. However, while travel expenses are important, you can regulate them with expense policies that define which items you’ll cover.
For example, you might choose to cover accommodation costs but not food expenses. Some companies, especially large ones, offer generous T&E expense allowances. These allowances might not suit small businesses, offering an example of why travel expenses are discretionary.
Workplace enhancements have taken a backseat in today's remote-first or hybrid working era. In the past, companies spent significant resources turning their offices into attractive places to work. For instance, companies like Apple and Meta spent significant resources to turn their offices into architectural beacons.
These days, workplace enhancements have changed. With many people working remotely, companies offer perks such as equipment allowances, home office upgrade allowances, and upskilling opportunities.
While these allowances are essential in attracting top talent, they are not considered mandatory spending. You can moderate your spending depending on the type of talent you wish to attract, making these expenses fully discretionary.
What is discretionary expense budgeting?
Budgeting for discretionary expenses involves using systems to monitor and track your discretionary spending. If you fail to monitor it, you might find expenses increasing too quickly, leaving you with unsustainable margins and no emergency fund for your business.
Here are five ways to avoid such a situation and reduce discretionary spending getting out of control.
1. Measure expense ROI
Spending on expenses that don’t offer you enough of a return on investment is an easy mistake to make. This mistake happens due to a lack of recurring expense tracking and feedback. For example, you might purchase a SaaS tool to boost productivity, but your employees might prefer another method.
The result is wasted expense that compounds if you are not alert to employee feedback. Take the time to record and track all your expenses. Categorize the business impact every spending decision has, and you'll manage to measure ROI.
Note that some expenses will not offer a quantitative return. For instance, you might struggle to measure the impact of a new HR system subscription. However, this expense might be justifiable if this system reduces employee onboarding time and payroll execution.
2. Categorize and track trends
Tracking trends in discretionary expenses is critical to squeezing the most out of your spending. Expense report trend tracking gives you the following benefits:
- Reveals your company's changing needs via the money you're spending.
- Gives insights into efficiency. You might be spending too much on manual processes and can reduce expenses with a tool.
- Helps you anticipate upcoming costs based on historical patterns.
- Exposes any seasonal spending patterns in your business.
Breaking your spending into business-relevant categories helps you quickly isolate problem areas. You can dig deeper into specific processes and create greater efficiency. The result is optimized spending and a better understanding of your discretionary spending limits.
3. Establish a cash margin of safety
Your business will experience periods of unexpected turbulence. In times like these, you’ll have to examine your discretionary spending and reduce expenses. Some companies reduce spending drastically, reducing employee morale, and potentially damaging vendor relationships.
A cash margin of safety or reserve will help you scale into your cost-cutting efforts gradually. You can spend more time analyzing your discretionary expense trends and create ideal spending levels without disrupting current workflows.
Most companies believe a six-month cash buffer works best. However, every business is different so take the time to decide what works for you.
4. Set up an expense review process
Take the time every quarter to review your current discretionary spending with your finance team and stakeholders. For instance, if you discover that sales travel spending has increased dramatically, involve your head of sales to understand the issue.
A good review process helps you remain on top of your company's needs. You might discover that some expenses have become non-discretionary. For example, sales travel spending might be non-discretionary currently because of the changes you made in your product lines or client roster.
Create review processes at logical business intervals, and you'll elevate your financial performance.
5. Define and enforce expense policies
You can best control discretionary expenses by defining expense policies. Some organizations struggle with enforcing their expense policies due to disjointed or slow approval processes. These days, you can automate expense approval and free your employees' time for value-added tasks such as expense trend analysis.
A good expense policy will define spending limits by department or by specific expense categories. These limits help you model worst-case expense scenarios and calculate margins. Make sure you involve department stakeholders before prescribing expense limits.
How Ramp helps you manage discretionary spending
Ramp's automated expense management software for small businesses and corporate cards platform helps you monitor discretionary spending and create a robust financial planning and analysis program. Here’s how.
Digitized expense policies
Forget manual expense approvals that confuse your employees and cost time. Ramp helps you digitize your expense policy, giving your employees full visibility into approved expenses. You can create rule-based expense workflows such as category or team-based spending limits.
Ramp also helps you set up dynamic and conditional expense logic that adapts to your business's financial goals. Collect receipts, match them, and set approval thresholds to simplify expense management in minutes.
You can issue vendor-specific virtual credit cards and offer employees the ability to request exceptional expenses. Control card spend limits in real time and always be on top of your discretionary spending.
You can also view business trip details in one place, including hotel bookings, flight tickets, and itineraries. Your employees can file out-of-policy requests and upload receipts seamlessly.
Analytics to track expense trends
Ramp centralizes all of your company's spending in one place, helping you track discretionary expenses and receive insights in real time. The platform's AI-powered engine highlights troublesome areas such as duplicate SaaS spending and unused partner rewards.
The result is greater ROI from your expenses. Ramp's powerful reporting platform helps you isolate spending based on every data point imaginable. Forecast your operating budget or drill deeper into your monthly expenses to reveal potential efficiency gains.
Drill deeper into expense trends per department or category and analyze them in real time. You can also export data from Ramp to your favorite analytics tool to simplify your analysis workflows.
Ramp helps you save money in several ways. Our cards offer 1.5% unlimited cashback on all spending with unlimited free employee cards. Plus, Ramp has no interest rate and no possibility of overspending.
Best of all, Ramp's deep database of SaaS expense data helps you benchmark your costs against your peers, helping you figure out price ranges.
Discretionary expenses can run out of control with improper monitoring. With tools like Ramp, monitoring your discretionary budget is simple. No matter what market conditions look like, you’ll stay on top of your spending, helping your business save money.