FLASH SALE! - "FINANCIAL MODELING COURSE BUNDLE AT 60% OFF" Enroll Now

Discretionary Spending

Updated on April 4, 2024
Article byAswathi Jayachandran
Edited byAswathi Jayachandran
Reviewed byDheeraj Vaidya, CFA, FRM

Discretionary Spending Definition

Discretionary Spending is the amount of money a business spends on initiatives or projects meant to increase its overall profitability but isn’t essential to its day-to-day operations. These costs can be avoided, but they are incurred as they comprise important factors in implementing growth strategies.

Discretionary Spending

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Discretionary Spending (wallstreetmojo.com)

Discretionary expenses are typically non-essential costs; their absence does not hinder necessary functions or the day-to-day operations of the business. These costs are nonetheless vital to its operation, as they provide several avenues for growth. Businesses frequently spend discretionary fixed expenses on initiatives that boost brand awareness or staff satisfaction.

Key Takeaways

  • Discretionary spending is the fund a company spends on activities that can help improve its growth but are not essential for everyday operations. The company can choose to avoid these costs even though they are beneficial.
  • A long-term reduction of discretionary costs can have detrimental effects on the quality of the goods and services of the company.
  • In the government, discretionary spending pays for the regular expenses regularly associated with federal government operations.
  • One can divide consumer discretionary spending habits into discretionary and non-discretionary spending.

Discretionary Spending Explained

Discretionary spending is categorized as the cost spent on expenditures that are not necessary for running the business’s day-to-day operations. Every month, businesses pay out a lot of money, yet only a small portion of those expenses are necessary to keep them running. Discretionary expenses do not belong to the list of necessities. These expenses vary from company to company and may be subjective in certain circumstances. It is primarily determined by the type of business conducted and the industry in which the organization operates. 

It is often difficult to assess the benefits of incurring discretionary expenses due to the lack of a clear correlation between cost input and output. As a result, when earnings decline, a business might initially reduce discretionary spending. Curtailing these non-essential expenses will not immediately impact profitability, at least in the short term. This allows them to cut unnecessary expenses, focus on the necessities, and increase profit. Examples of discretionary costs include advertising, training, research and development (R&D) costs, etc.

Similar to how discretionary costs vary from company to company, cutting them also varies from one to another. One does it only after careful consideration, keeping the immediate and long-term requirements in mind. For example, one can reduce marketing costs for a short time, but they must eventually reinstate it because they may limit the product or service’s reach in the long run. A long-term reduction of discretionary costs can have detrimental effects on the quality of the goods and services of the company. It can reduce customer awareness and increase machine downtime and employee turnover.

Government And Individual Spending

In the government, discretionary spending pays for the regular expenses regularly associated with federal government operations. Grants, procurement of equipment and other assets, and contractor services that support numerous federal programs and activities are also funded by it. In terms of government, one can divide federal spending into three categories: discretionary spending, mandatory spending, and net interest costs.

In the case of individuals, their spending habits can be discretionary and non-discretionary spending. Non-discretionary or necessary expenses include rent, mortgage, electricity, and water bills. Payment of these expenses is necessary and unavoidable. On the other hand, Netflix and gym subscriptions are discretionary expenses. They are necessary and help in maintaining physical and mental health. However, such consumer discretionary spending expenses are avoidable when living costs increase.

Examples

Check out these examples for a better idea:

Example #1

Suppose Dan owns a manufacturing company and has observed a sharp decline in product sales. He wanted to look into it, but because it was a deep-rooted issue, it could take months to recover. However, he should keep the business running until he can solve the problem, and one of the ways he could save the business is through short-term cost-cutting. His company was about to recruit some new people to expand the business.

Dan decided to curtail the training programs. These initiatives give staff members the resources they need to do their jobs well, but the program becomes an avoidable cost if a company is no longer adding new team members. The money saved from recruiting and training new members can be used to correct the existing issues within the company.

Example #2

Suppose David owns a company. He noticed that profits for the quarter declined and expenses were high. He had to cut down the discretionary expenses for the time being, and looking at various expenditures, he realized that there were too many software license purchases even though they had used only very little. The goal of these purchases was to improve the productivity and workflow of the employees.

A few software programs added more value, but employees rarely used it. Their renewal time was near, and David decided not to renew them for the time being and to do so only when necessary. This way, the payment will not be wasted on unused time and can be used to address other issues. 

Example #3

Efforts were made to raise the $31.4 trillion debt ceiling and avoid imminent default in the U.S. While Social Security and Medicare cuts were ruled out due to their significant budget share, the focus shifted to trimming funds for various programs, posing potential economic growth challenges. Discretionary spending, accounting for 27% of the overall expenditure in 2022, faced proposed cuts, with debates revolving around spending caps and durations. Notably, discussions sidestepped addressing primary drivers of U.S. debt, such as escalating retirement and health costs, suggesting potential long-term fiscal challenges.

The reduction of spending is considered whenever there is a need to address the growing concern about the budget deficit and national debt. Policymakers seek to control government spending and close the budget deficit by cutting back on discretionary spending. Reducing the tax burden on taxpayers or directing resources to other priority areas are also made possible by limiting the spending.

Discretionary Spending vs Mandatory Spending 

Here are the main differences between the two:

Key PointsDiscretionary SpendingMandatory Spending 
Meaning   Discretionary spending refers to the funds allotted by Congress to pay for the operational costs of the executive branch agencies, the offices and agencies of Congress, and the government’s overseas operations.   Funds granted under legislation other than appropriation acts are called mandatory spending, also known as direct spending.  
Legislation   Annual appropriation acts, which are governed by the House and Senate Appropriations Committees, provide funding for discretionary spending. Congress and the President must annually approve and appropriate this money to keep the government functioning.  Mandatory spending is not generally determined by annual appropriation acts but rather by statutory requirements.  
Examples   For instance, numerous federal programs and initiatives, as well as the majority of the defense, education, and transportation programs, are supported in this way. It includes the allocation of funds for staff salaries and operating expenses.   Examples are Medicaid, Social Security, and Medicare. It also includes several smaller programs such as (unemployment benefits, federal employee retirement plans, student loans, deposit insurance, etc.) 

Frequently Asked Questions (FAQs)

What is non-discretionary spending?

Non-discretionary spending in the context of personal budgets refers to purchases made for necessities of everyday living. These costs happen despite an increase in the cost of living. Examples include rent and mortgage liabilities, housing, debt, taxes, and food.

What is discretionary spending in the federal budget?

Federal discretionary spending in the United States refers to the portion of the budget selected by Congress each year during the appropriations process. Defense and education fund allocations are examples of federal discretionary spending.

What are discretionary spending limits?

It refers to the maximum amount the statutory budget authority (or outlays) allocates that is permitted for a given fiscal year. In other words, this spending allocation determines the total discretionary expenditure for the fiscal year.

How are entitlements different from discretionary spending?

In US fiscal policy, mandatory spending—also known as entitlement spending—refers to government funding for certain programs mandated by law. Congress must finance entitlement programs. In contrast to discretionary expenditures, this can vary from year to year.

This article has been a guide to what is Discretionary Spending & its definition. Here, we explain its examples and differences with mandatory spending. You may also find some useful articles here –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *