Segment margin

From CEOpedia | Management online

Segment margin is an amount of new profit (or net loss) generated by segment of the business. If the company business is differentiated, e.g. products are on different markets, different types of products are merchandised, it is convenient to compare different margin obtained by different segments of the company. For example, segment margin on product A in country Z can be larger than for the same product in country Y. In other example, on the same markets product B can have larger segment margin than product C. To calculate segment margin it is necessary to take away expenses from revenues, that are relatedo to the segment. In case of general costs, they should be divided between segments in order to get proper result(E. Chang,Y. Luo, J. Ren, 2014, p. 411-422).

Segment Reporting

To do the report of segments - business is divided into different parts, depending on geographic area, product lines and other important information, that can supply individual data about every of segment. The example can be the grocery chain. Every store will be the segment in that case. Moreover, if for different product lines(meats, fruits, milk) we use different decision-making and accounting systems - they are different segments also. Nonsegmented financial documents are the same as segmented financial statements. Everything that differs in that documents is: in the segmented financial statements is recorded how much of profit brings every of segment. The segment margin is a helpful evidence of a profit of every segment. In that case when the result is negative: the keeping of that segment should be stopped until it brings the worth to other segments. If in a segment's margin are set traceable fixed costs, it means that these costs exist only because of the existing of that segment. For example, salaries for the manager of some segment would be such cost that is connected directly with a segment (Imea, 2014, p. 427).

Common cost - is a cost, that is divided on two or more entities or segments. In that situation when common costs are distributed to segments, the segment margin's worth is decreasing. However, some business distribute common costs only in that case when the segment is finished. Common cost are usually hard to be kept under the control by the department manager, who is responsible for costs. It can cause problems in identification of the profitability of the segment, that we want to explore individually(Imea, 2014, p. 428).

Segment margin allows to measure enduring profitability and is useful in making such important for business decisions as whether to start some product lines or finish them.

Moreover, managers of investment centers are responsible for that part of money that are invested in generating profit. Only in that case they can be responsible for the expenses and revenue of the segment. These managers have the right for making such decisions as: changing the structure of the facilities, buying new equipment, increasing the facilities or for example, set new locations(P. Sivabalan, J. Wakefield, R. Sawyers, S. Jackson, G. Jenkins, 2018, p.215).

Segmented profit and loss statements

Segmented profit and loss statements are created for calculation of the profit for every main segment in the company. It is uncomplicated to get and keep records of trades for the segment. However, tracing cost to one definite segment or making the decision how to treat costs among the segments can be a very hard-making decision.

Changeable costs are usually traced directly to the segment. Variable cost differ in a proportion to the trade volume. Also, that costs might be distributed to a segment that is based on trade volume(P. Sivabalan, J. Wakefield, R. Sawyers, S. Jackson, G. Jenkins, 2018, p.216).

Analysis of the all segments of the organization is done when we have to make decision about:

  • which costs to allocate
  • which costs to assign

Segment costs must compromise all costs, that are connected with that segment - only these costs that appeared because of that definite segment. The problem that can come up is: many fixed costs are not direct.

To get the answer on the question whether to allocate the fixed costs to the segment we should decide whether these costs can be eliminated or reduced in the situation if the segment would be abolished(P. Sivabalan, J. Wakefield, R. Sawyers, S. Jackson, G. Jenkins, 2018, p.216).

Positive and negative segment margins

The result of segment margins can be:

  • positive: the direct costs are smaller than the revenue of the segment. The segment is able to cover the costs, that were caused because of that segment, and moreover - to bring some part of revenue to overall operating income. So, the decision for that segment will be - continue the keeping of that segment.
  • negative: the directs costs are bigger that the revenue of the segment. The management of the organization should eliminate the segment.

But the overall common costs will be incurred. No matters, which decision will be made by the management. These costs are called - unavoidable costs. Other costs, that left, should have enough of contribution margin for covering all costs - common and direct(B. E. Needles, M. Powers, S.V. Crosson, 2010, p. 1194).

Segment Profitability Analysis

Contains the development of the preparing of the segmented income statement. During that process variable costing are used for defining the fixed and variable costs(B. E. Needles, M. Powers, S.V. Crosson, 2010, p.1194).

Principles of Accounting, Belverd E. Needles, Marian Powers, Susan V. Crosson, Cengage Learning, London, 2010, p. 1194

The difference between segment margin and contribution margin

The contribution margin is that number that is left if we will minus irregular costs from sales revenue. The contribution margin is very helpful in planning process during the making decisions. For example, these one where fixed costs will not become different with time. But the segment margin is that number that is left from the contribution margin after withdrawing traceable fixed costs. The segment margin is helpful in calculation of what is the total profit of the individual segment(M. M. Mowen, D. R. Hansen, D. L. Heitger, 2013, p. 365).

Examples of Segment margin

  • Retail Segment Margin: Retailers measure segment margin as the net profit generated by selling a particular product or product line. For example, a retailer may calculate the segment margin for a clothing line as the total gross revenue earned from selling the clothing line, minus the cost of the goods sold, minus the cost of operating the store.
  • Manufacturing Segment Margin: Manufacturing businesses measure segment margin as the net profit generated from producing a particular product or product line. For example, a manufacturer may calculate the segment margin for a certain type of car as the total gross revenue earned from producing the car, minus the cost of labor and materials used to make the car, minus the cost of operating the factory.
  • Service Segment Margin: Service-based businesses measure segment margin as the net profit generated from providing a particular service or service line. For example, a consulting firm may calculate the segment margin for a certain type of consulting service as the total gross revenue earned from providing the service, minus the cost of labor and materials used to provide the service, minus the cost of operating the consulting firm.

Advantages of Segment margin

Segment margin provides an insight into how profitable different segments of the business are, allowing for better management and optimization of resources. It has the following advantages:

  • It allows for better allocation of resources by enabling a company to identify the most profitable segments and invest more resources into them.
  • It helps to identify areas of the business that are not performing well and need improvement.
  • It enables better understanding of the overall financial performance of the business by providing a more detailed picture of profits and losses.
  • It helps to identify areas of the business that are underperforming in comparison to the others.
  • It enables better planning and budgeting of resources by providing a more granular view of profits and losses.

Limitations of Segment margin

  • Segment margin does not reflect the whole picture of the company’s financial performance. It only captures the financial performance of the specified segment, without considering the performance of other segments or the company as a whole.
  • Segment margin is based on the reported figures of sales and costs, which may not be as accurate as the actual figures.
  • Segment margin does not include the fixed costs of the company, which can have an effect on the overall profitability.
  • Segment margin does not consider the cost of capital, which can also have an effect on the overall profitability.
  • Segment margin does not consider the cost of acquiring customers, which can also have an effect on the overall profitability.
  • Segment margin does not consider the effect of inflation on the segment’s performance.
  • Segment margin does not consider the effect of external factors, such as competition or changes in the economic environment, on the segment’s performance.

Other approaches related to Segment margin

  • Contribution margin analysis: This approach looks at the difference between sales and variable costs to determine the profitability of a segment.
  • Absorption costing: This approach examines the fixed costs associated with a segment and allocates them accordingly.
  • Profitability analysis: This method breaks down the segment margin into component parts, such as direct costs and overhead, to determine the profitability of the segment.
  • Value-based management: This method takes a more holistic approach, looking at the company as a whole and examining how each segment contributes to the overall value of the company.

In summary, segment margin is an important tool for understanding the profitability of a business segment. Other approaches such as contribution margin analysis, absorption costing, profitability analysis, and value-based management can also be used to analyze the profitability of a segment.


Segment margin — recommended articles
Variable Cost Ratio — Cost per unit — Allocated cost — Differential costing — Operating expense ratio — Conversion cost — Double counting — Absorbed costs — Costing system

References

Author: Diana Fandul

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