Discretionary Cost to Sales Ratio

Definition

The discretionary cost to sales ratio allows analysts to quantify the unrestricted expenses that can be eliminated in the near term.  When faced with an economic or industry downturn, companies can bolster profits by eliminating what are deemed optional expenses.  Calculating their discretionary cost to sales ratio allows companies to understand the magnitude of this opportunity.

Calculation

Discretionary Cost to Sales Ratio = Discretionary Costs / Sales Revenues

Where:

  • Discretionary costs include expenses such as routine maintenance, service contracts, employee training, meals, entertainment, travel, as well as participation in efforts such as syndicated research.

Explanation

When the economy enters a recession or an industry pulls back, companies oftentimes look for ways to lower expenses in the near term.  By taking an inventory of what might be seen as discretionary costs and normalizing this value against sales, the company has a better idea of the potential lift in gross profit margin.

Unfortunately, reducing discretionary expenses in the near term can result in a substantial increase in future expenses.  For example, delaying routine maintenance in the near term may result in significant repairs to equipment in the future.  For this reason, reducing discretionary expenses is deemed a near term strategy to meet an immediate need.

Example

Company A's industry was hit hard by what the forecasting team believes will be a near term reduction in sales due to an economic recession.  Company A's management team asked their business analysts to pull what they've concluded are discretionary expenses from last year's actual results.

The table below was provided to Company A's management team, which concluded they could offset a loss of nearly 4% of sales by eliminating discretionary costs.

Discretionary Costs  
Service Contracts $295,218
Periodic Maintenance $177,131
Syndicated Research $161,028
Meals and Entertainment $64,411
Industry Conferences $42,941
Employee Travel $32,206
Total Discretionary Costs $772,934
Sales Revenues $21,470,400
Discretionary Costs to Sales Ratio 3.6%

Related Terms

sales to working capital, maintenance to fixed assets ratiodepreciation to fixed assets ratio, capital to labor ratio, fringe benefits to salaries expense, sales expense to sales ratio, interest expense to debt ratio