Definition: Mandatory spending is expenditures that are essential for a business’ operation. This term intends to differ what is essential and what is not. Decision-makers can’t eliminate, radically diminish or delay a mandatory spending without affecting the business’ regular functioning.
What Does Mandatory Spending Mean?
Expenditures are either mandatory or discretional. In a country, government’s mandatory spending is established by the law. It means that no reduction is possible without changing the law. In business, mandatory expenses are those considered absolutely necessary to sustain normal operations. Given a particular business model, all elements that make it possible represent mandatory spending.
For example, most manufacturing companies consider monthly purchases of certain raw materials as mandatory costs because they guarantee continuous production. Payroll for operational staff working with manufacturing equipment might be also a mandatory expense but travel expenses are surely discretional. When the company’s income falls below expectations managers are normally inclined to maintain mandatory spending and at the same time to eliminate some discretionary costs.
Example
Stanphill & Flake is an editorial firm that produces a wide range of printed books. The company is facing a severe downturn because of the rise of e-books. Annual sales dropped 40% in two years and the firm lost money for the first time in decades. One of the directors proposed a radical cost-cutting plan that meant a reduction of 50% in all expenses. However, another director pointed that mandatory spending should remain the same because the company had to guarantee its operations. The Finance Manager then identified mandatory versus discretionary costs.
For example, he found that graphic designers, printing machine operators and marketing people should be kept because they perform crucial activities. However, expenses related to Christmas gifts for employees, Summer Camps for the employee’s children, new furnishing for offices and productivity bonuses for managers could be eliminated. At the end, Stanphill & Flake was able to reduce costs in 30% while a new strategy to launch e-books was implemented.
