Discretionary Expense Definition, Examples, Budgeting

What Is a Discretionary Expense?

A discretionary expense is a non-essential expense. Discretionary expenses are costs without which businesses or households can survive. As such, they are defined as being wants rather than expenses that are needed. This means a business or household is still able to maintain itself even if all discretionary consumer spending stops. Meals at restaurants and entertainment costs are examples of discretionary expenses.

Understanding Discretionary Expenses

Expenses are divided into several categories, namely non-discretionary and discretionary. While non-discretionary expenses are considered mandatory—housing, taxes, debt, and groceries—discretionary expenses are incurred above and beyond what is deemed necessary. These are generally considered wants, while non-discretionary expenses are usually referred to as needs. As such, discretionary expenses rarely have anything to do with a business or household's day-to-day operations. Rather, they cater to choice and lifestyle.

Businesses and individuals pay for discretionary expenses with discretionary income—the amount of money left over after paying for housing, food, taxes, and other necessities. When times are good, people have more money to spend, and they normally do so on things they don't need, such as luxury items and other services—cars, vacations, restaurants, entertainment, electronics, etc.

When times get tough and short-term cash flow issues emerge, managers and individuals often try to weed out any unnecessary costs. Discretionary expenses are normally the first to go because stopping them is unlikely to have a major impact on a business or household.

Corporate discretionary expenses are usually linked to the promotion of a company’s market position. Buying the raw materials used to produce goods is usually considered essential. Spending money on employee training programs is not usually considered essential. Individuals may also find times when they need to consider cutting out certain expenses. For example, a person who runs into financial difficulties is more likely to prioritize paying utility bills over financing a vacation.

Special Considerations

What constitutes a discretionary expense is subjective. As such, it may differ considerably among individuals and businesses.

For example, a stable, well-established company could probably get away with slashing its advertising budget for a while if the need arises. A new company facing hardship, on the other hand, would probably need to make cutbacks elsewhere, being mindful that boosting exposure and getting its name out there is imperative to keeping the business afloat.

The same principle applies to individual consumers as well. Some people may only be able to afford a daily Starbucks run when things are going well. They may consider cutting out this expense when times are tough—or if they're saving up for a big expense, like a home or a car.

Types of Discretionary Expenses

As mentioned above, discretionary expenses are any costs that a consumer or business wants rather than needs. Some common discretionary items include:

• Vacations and travel expenses
• Automobiles
• Alcohol and tobacco
• Restaurants and other entertainment-related expenses
• Coffee and specialty beverages
• Hobby and sports-related expenses, such as crafting, sewing, and gym memberships

It's important to point out again that what defines a discretionary expense depends on who's doing the buying. For instance, buying a new car may be considered a want for one person, but it may be considered essential for someone who has a long commute to work where driving is the only option.

How to Budget for Discretionary Expenses

It may be necessary for households and businesses to cut back on certain expenditures in response to decreases in income during tough economic times. That's why it's a good idea to track discretionary expenses separately from essential ones so that it is easy to see how costs can be reduced.

One helpful budgeting tactic is to rank discretionary expenses in order of importance from the least to most important. If a job loss or income reduction forces budget cuts, household members or a company's management team can easily identify the first discretionary expense to place on the chopping block.

Discretionary Expenses vs. Non-Discretionary Expenses

Expenses are divided into discretionary and non-discretionary costs. In other words, essential and non-essential expenses. Some expenses, such as vacation costs and luxury items, are not necessary to maintain a household and, thus, are classified as discretionary expenses. The income earner can pay for these goods or services at their discretion.

Certain expenses, though, must be paid to keep things running. These are called non-discretionary expenses. These are considered essential expenses, as the income earner must regularly pay them or suffer the consequences.

Examples of non-discretionary spending include housing costs, taxes, and health insurance for individuals. Payroll, warehousing costs, and transport are non-discretionary expenses for businesses.

The Bottom Line

Costs are divided into several categories. Some are essential while others are not. The first, which includes essential and mandatory items, are called non-discretionary expenses. This is contrasted to discretionary expenses. These costs are deemed non-essential, such as vacations, luxury goods, and nights out. Discretionary spending happens when all non-discretionary costs are covered. Keep in mind that these are needs and can be sacrificed when times get tough.