Inflexible Expense

What Is an Inflexible Expense?

An inflexible expense is one that cannot be adjusted or eliminated by a company or individual. It is often the result of a contractual obligation or a long-term obligation that can not be easily adjusted or discontinued. Inflexible expenses are often called fixed expenses.

Understanding Inflexible Expenses

An inflexible expense is a recurring required payment or debt. It likely is a fixed amount whose payment stream is unalterable. For an individual, a typical inflexible expense would be a mortgage, car payments, alimony, or child support, which have fixed repayment schedules by amount and date. For companies, interest, rent, and insurance are inflexible expenses. Salaries are also considered an inflexible expense, though only if the employee is paid independently of hours worked or units produced.

It is important to distinguish which expenses are inflexible. For individuals, these types of costs may prevent them from taking out personal loans. For companies, these types of costs increase operational risk.

The risk behind inflexible expenses is the entity incurring the cost must pay the expense regarding supporting income. An individual must still pay inflexible expenses such as car payments or mortgages should they lose their job. Households should be mindful of which expenses are inflexible, how the loss of income will impact their ability to cover these costs, and how long emergency savings may last considering inflexible expenses.

Alternatively, a company must still pay inflexible costs regardless of business operations. On one hand, companies can use inflexible costs to leverage growth. Agreeing to inflexible contracts allows a company to lock into favorable rates today and remain with those rates as the company grows. However, should company profits falter, the company will be forced to make payments using smaller than expected proceeds.

Inflexible vs. Flexible Expenses

A flexible expense is easily altered or avoided. Flexible expenses are costs that can be adjusted by the amount or eliminated by the consumer.

In personal finance, flexible expenses are costs that are easily changed, reduced, or eliminated. For example, entertainment and clothing are flexible expenses. Even necessary expenses, such as groceries, can be considered flexible because the consumer adjusts the amount spent.

A company often makes use of flexible expenses to scale costs based on business needs. Consider a manufacturing company that only buys materials when it needs to produce more goods. Should the company want to manufacture one additional unit, it pays hourly workers the time to make the good and only buys enough materials to make that unit. The company can easily decide to forgo manufacturing that additional unit. Though the company may lose potential revenue, it can elect to avoid the flexible expenses.

In general, flexible expenses are safer for both individuals and companies. However, they may be more expensive as the consumer pays a premium for the flexibility. For example, imagine a subscription service. The service is often priced to be more expensive should the client elect to pay month-to-month. If the client agrees to a long-term plan (i.e. an annual contract), the client gets a pricing discount but loses flexibility.

Special Considerations

For companies, the concept of inflexible and flexible costs is a managerial accounting concept. Both types of costs are accounting for similarly for external reporting and Generally Accepted Accounting Principles. These two types of costs are most useful for making strategic operational decisions and performing internal financial planning.

Relevant Range

Inflexible costs often exist within a relevant range. A relevant range is a specific activity level that dictates a specific level of service. Should an individual or company shift to a different relevant range, the inflexible cost will change.

For example, imagine a company pays rent on a 10,000-square-foot warehouse. The company pays $1,000 per month. This rent is an inflexible cost, but if the company should need to double the size of its warehouse, the company's square footage relevant range will increase. Therefore, the company's inflexible expense will increase to $1,600 per month, the market rate for 20,000 square feet.

The relevant range also increases based on the number of underlying variables. Imagine an individual has a monthly car payment of roughly $300. Should the individual decide to buy a second car, the relevant range has doubled, and the individual now has two car payments of $300. Should the relevant range increase again, the individual now owns three cars and must pay ~$900/month.

Personal Loans

Inflexible expenses are one of several criteria considered by lenders in granting personal loans, mortgages or auto loans. Personal loans are not secured by collateral, unlike a mortgage or car loan, so eligibility criteria are stricter. Lenders closely examine current sources of income and monthly expenses.

Even if the applicant has strong earnings, lenders measure debt by evaluating the amount on credit cards as well as inflexible expenses. The debt-to-income ratio (DTI) equals total monthly debt payments divided by gross monthly income. A lender analyzes both the back-end ratio to analyze inflexible costs excluding housing costs as well as the front-end ratio to analyze inflexible costs including housing costs.

For example, a borrower with $6,000 in monthly income and $2,000 in monthly debt payments has a DTI ratio of 33 percent. Lenders look for a DTI ratio of no more than 43 percent, which is the maximum mortgage lenders allow applicants to have. If an individual has too many inflexible expenses, they will not qualify for a home loan if their income is not high enough.