As a business owner, discretionary income is a term you should be familiar with because small business growth depends on the amount your customers have at their disposal.
Let’s look at what it is, its examples, its importance, and how you can calculate it for your finances.
What is Discretionary Income?
Discretionary income is the amount of money left over after accounting for taxes and personal necessities, including food, housing, etc.
In other words, it’s the available income you can use for saving, investing, or spending on non-essentials, which can include anything from eating out to taking a vacation.
As a business owner, it’s essential to understand the term as it directly impacts your company's success.
For example, small businesses tend to suffer during economic recessions as their customers don’t have enough discretionary income.
Learn how to calculate net income.
Examples of Discretionary Income
- Money left over after you have paid for your housing, food, transportation, and healthcare costs
- The money you may earn from selling items on eBay, Craigslist, or at a garage sale
- Income from a part-time job or side hustle that is not related to your main career (i.e., driving for Uber)
What is discretionary income in business?
Businesses use the term to refer to the amount of money that remains after all necessary expenses you have paid.
This can include rent, taxes, transportation costs, employee payroll, and other essential expenses.
This allows businesses to invest additional resources in marketing or product development.
Differences Between Discretionary Expenses vs. Non-Discretionary Expenses
Households and businesses pay for discretionary expenses that aren't considered necessary for survival.
Some examples of a discretionary payment are:
- eating out
- playing golf
- attending an amusement park
- going to a museum
Discretionary expenses go up and down depending on how much income is available to spend after paying for basic needs.
Must-haves like food, water, housing, vehicle fuel, and utilities are purchases you make to live daily.
In addition to living expenses, other non-discretionary expenditures are:
It's a good idea to track both personal and business non-discretionary expenses to analyze where you might be able to reduce spending and increase your available income.
- mortgages and credit card payments
- personal property taxes
- real estate taxes are not included in a mortgage payment
- auto/home/health insurances
- health care costs
Suggestions to reduce non-discretionary expenses include buying food in bulk, shopping for the best price on goods and services, paying off credit card balances each month to save fees and interest, and refinancing your mortgage.
How discretionary income can change
Changes in income, the number of family members, and the Federal government's poverty guidelines that update annually affect a person's discretionary income.
Take into account that poverty guidelines aren't the same for each state.
Because of these changing variables, you should resubmit new information if you have an income-driven repayment plan (IDR) to repay a Federal student loan.
Typically, IDR payments are 10% to 15% of your discretionary income.
These payments adjust based on variables mentioned earlier; for example, if you have a student loan, your payments could increase or decrease.
In some cases, changes can result in zero loan payments.
Apply for a loan
Discretionary vs. Disposable Income, Profits, Revenue, and Cash Flow
Discretionary earning is the money you have leftover after taxes and personal necessities. So, how does that differ from disposable income, profits, revenue, and cash flow?
Discretionary and disposable income are often used interchangeably, but they are not similar. Disposable income is your total personal income minus taxes.
Unlike discretionary income, you can use it for both essential (like food) and non-essential expenses (like a vacation).
Disposable income examples
Disposable income measures the money you have left over after paying taxes and other obligations.
For example, if your total monthly income was $1,000, but you had a monthly payment of $200 in federal taxes and another $50 for state taxes, your disposable income would only be $750.
If you have a lot of disposable income, you may be able to save up for a major purchase, such as a new car or a down payment on a house.
Alternatively, you could use your disposable income to travel or take expensive vacations. You could also use it to invest in the stock market or donate it to a charity or a cause that is important to you.
The revenue is the total amount of money your small business generates before deducting any expenses.
Revenue typically refers to money made from sales, but it can also include income from rental income, interest, and other sources.
Profit is all of your business's revenue once you have paid for all expenses. After paying for all expenses, every dollar your business earns counts towards your business profit.
There are three different types of profit
: gross, net, and operating profit.
The difference between discretionary cash flow and disposable income is the money that flows in and out of your business.
refers to the money your business has on hand at any given time.
If you have positive cash flow, your business has enough cash on hand to cover all necessary business operations and expenses.
How to Calculate Discretionary Income
Calculating discretionary income lets you know how much money you have left over after expenses and paying for necessities.
Inputting incorrect information in either formula results in inaccuracies.
This adversely affects financial projections and subsequent monetary decisions.
There are 3 ways you can calculate it, and both are very simple. The other one is using a discretionary income calculator.
Discretionary Income Formula #1
Discretionary Income = Post-tax income – Necessary expenses
For example, if your take-home pay is $5,000 per month after taxes, and you have $2,500 in necessary expenses, your discretionary income would be $2,500 per month.
This is the amount you are free to put in savings, invest, or spend on luxuries.
Discretionary Income Formula #2
Alternatively, you can calculate your discretionary income using the same method that the federal government and lenders use for the purpose of student loan repayment plans.
The US Department of Education calculates discretionary income based on the poverty guidelines
. Using this method:
Discretionary Income = annual income – 150% of the poverty guidelines for your family size
For example, if your annual income is $60,000 and there are three people in your family, your discretionary income would be $28,005. Your monthly discretionary income would be this number divided by 12. In this case, it would be $2,333.75 per month.
Use these tips when calculating discretionary income:
- Be familiar with where to find information on your pay stub and tax return.
- Formula #1 uses available income after taxes. Example: the net amount on an employee's paycheck. Whereas Formula #2 uses a person's adjusted gross income found on their tax return.
- When using Formula #2 for the student loan debt, follow the Department of Education guidelines. You can change between IDR plans as often as necessary as long as you meet the requirements.
- If your income or family size decreases or increases, recalculate your discretionary income to see how it affects how much you can spend.
How Does the Discretionary Income of Your Customers Affect You as a Business Owner?
Why does discretionary income matter to you as a business owner?
Small businesses that sell discretionary goods or services tend to suffer during economic recessions and financial crises.
People don’t have as much money to spend on luxuries during these times, making it difficult for small businesses to stay afloat.
By understanding this concept, you can take steps to attract customers during periods when discretionary spending is lower.
For example, say you run a hair salon. During a recession, your business would likely slow down as your regular customers don’t have enough discretionary income to get a haircut or a new hairstyle.
In order to encourage customers to come to your business, you could offer discounts. For instance, you can reduce your prices for families that come together. These types of promotions are great ways to encourage new business during times of crisis.
Tips to Make the Most of Your Discretionary Income as a Business Owner
How can you use your discretionary income to grow your small business?
Let’s take a look at a few simple ways business owners can use their leftover income to encourage growth.
Pay your debt
Paying off your debt
is a great way to utilize your discretionary income to help your business.
Once you have met your debt obligations and paid all of your business expenses, consider using some of your discretionary income to make additional loan payments.
Not only will this help you pay off your debt faster, but it will also save you money in interest and will increase your business’ cash flow.
Invest in your business
In order to grow your business, you need to invest in your business. As a business owner, you can use some of your discretionary income to pursue new business ventures and help your company generate more revenue.
In addition to this, you should consider using a small business loan
to invest in your business.
You can use small business loans for almost any purpose, from hiring personnel to buying equipment or making renovations. These loans are an excellent resource for small business owners who need financing.
20 Ways To Grow Your Business With A Loan
Save for retirement
Lastly, you should consider using your discretionary income to start saving for your retirement.
As a small business owner, you may not have the same benefits package as if you were an employee at a company.
You should take it upon yourself to start planning for retirement.
You could use some of your personal discretionary income and invest it in your own business.
This can be a good idea, but you also need to be careful, you wouldn’t want to use the capital you could have used to save for your retirement, or that could help your family in other ways.
That’s why most of the time, it’s advised that if you need money to invest in your small business, you get a small business loan.
Discretionary income is an important concept for business owners to be familiar with.
Not only does discretionary income affect consumer spending, but you should also know how to use your discretionary income to grow your business.
In order to maximize your income and help your business prosper, you should also consider using a small business loan to fund new business ventures.
Are you familiar with Camino Financial’s business loans? With our small business loans, you’ll be well on your way to building yourself a good credit score.
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How do you figure out your discretionary income?
To figure out your discretionary income, start by adding up all of your fixed expenses: rent or mortgage, car payments, insurance, groceries, etc.
Once you know how much you need to cover your fixed expenses each month, subtract that from your monthly income. Try to determine the average discretionary spending per month, so you can improve it.
What discretionary income is used for?
Many people choose to use it for things like travel or nightlife or to boost their savings and investment portfolios. Others may choose to simply live a more comfortable lifestyle by upgrading their home or wardrobe.
How much discretionary spending per month?
It depends on the person's lifestyle and spending habits. A general estimate for a moderate spender would be around $200-$300 per month, but it could be more or less depending on the specific situation.
Some people may only need $100 per month for discretionary spending, while others may need $500 or more. The main thing to keep in mind is that everyone's situation is different, so it's important to track your own spending patterns and figure out what works best for you.
What is discretionary income for student loans?
The Federal government provides loans to students by determining their discretionary income. If you're married, the type of repayment plan determines whether you add your spouse's income. In most cases, you should add spousal income if you file a joint return.
Multiply that amount by 150% and subtract your income. That figure represents the amount of available discretionary income when asking for federal student loans.
With lower-income or larger family sizes, discretionary income might be zero, leading to zero monthly student loan payments.
To maximize this income, it is important to carefully manage your monthly student loan payment and take advantage of any repayment or student loan forgiveness programs available to you.