Segment Margin is the assessment of the profitability of any segment under the same company, the segment can separate by product line, geography location, or the subsidiary. The management needs to know their reporting by segment which analyzes the profit and loss to evaluate each segment. Some segments may need to close down as they produce less profit. By close down some operations, the company will be able to focus on the main business that generates good profit. In order to make a decision, we need to have a report on the segment margin.
Segment Margin Formula
We can calculate segment margin by deducting all the expenses from the segment revenue, please refer to the following formula:
|Segment Margin = Segment Revenue – Segment Expenses|
ABC is a group company that operates across the US, EU, and Asia. It produces multiple products within these countries.
We can access the segment margin by dividing the revenue and expense by category as following:
- Product Line
What are the Advantages of Segment Margin Analysis?
|Advantages of Segment Margin Analysis|
|Identify the strength and weakness||The company needs to know its strength and weaknesses. When the segment is profitable, we have to analyze if there are remaining market share which we will be able to obtain when we increase the operation. If so, we should inject more resources to maximize our profit in that segment. If the segment is not doing well, we have to analyze the cause of it. The right strategy must be put in place.|
|Performance appraisal||The high-performance management needs to receive a high reward as well. Usually, there is the leader in all the segment, we need to reward them base on their performance, it also a factor which will force them to work hard and achieve higher goals next year.|
|Strategy Plan||The top management needs this information in order to consider expanding or shut down the operation of each segment.|
What are the Disadvantages of Segment Margin?
|Disadvantages of Segments Margin|
|Unidentified cost||Not all the costs can be fairly allocated across the segments. There always costs that cannot identify such as branding, goodwill, management fee, core system and so on.|
|Cost allocation||Even we can identify all the costs, but the allocation of them is not easy. It is almost impossible to allocate all these costs fairly across all segments.|
|Internal Supply||Some products need to supply within the same company. It will lead to the problem of the transfer price. If the seller wants to increase the fee it will impact the buyer.|
|Conflict between segment||Each segment will try to maximize their profit which may hurt the overall company performance.|
Segment Margin Vs Contribution Margin
Contribution margin is the product’s sale less its variable cost. It present in both amounts and percentages. We use the contribution margin to calculate the breakeven point as it presents the amount left to cover the fixed cost. So when contribution is equal to fixed cost means the business is breakeven. Moreover, it is also a tool to evaluate company profitability when it shows the relationship between the sale and profit.
We use the contribution margin to evaluate each product type or while the segment margin to evaluate each segment’s profit and loss.
The Segment Margin is a tool to evaluate each segment and benchmark all of them together to find the best performance and the one needs to improve.
Segment Contribution Margin
Segment contribution margin is the segment’s sale less its variable cost. The costs are included avoidable costs only as they are correlated with the sale. These costs are expected to fluctuate in linear with the sale change.
The segment contribution margin can be positive or negative depending on the cost and sales generated from each segment. If it is positive means that segment has remaining amount to cover the fixed cost within the period. If it is negative, means that the segment is making a loss. The loss is equal to fixed cost plus the negative contribution.
For a segment with a negative contribution, the management should consider shut it down or revise the strategy as they are making a huge loss. The sale generates cannot even cover its variable cost.