What Is Segment Margin?
Segment margin is the amount of profit or loss produced by one component of a business. With large companies, just knowing the gross margin for the entire business is not always enough. Knowing the segment margins for each division of the company that generates both expenses and revenues provides a more accurate picture of where the company is creating the most value and where its strengths and weaknesses lie. Segment margin can also be used for understanding a company's profit for specific geographic regions.
Analyzing segment margins can be useful for determining the vulnerability of a company's overall gross margins. Also, many publicly-held companies must report the profitability of segments of their business to the Securities and Exchange Commission (SEC).
- Segment margin is the amount of profit or loss produced by one component of a business.
- Segment margin only takes into account the segment's revenue and expenses.
- Segment margin helps to provide an accurate picture of where a company is performing well and where it's not by its strengths and weaknesses.
Understanding Segment Margin
Segment margin analysis is important because it helps management understand which divisions or product lines of the business are performing well and which are not. By understanding the various segment margins, management can allocate resources properly and, if necessary, eliminate unprofitable product lines.
Segment margin can also be applied to:
- Sales territories
- Geographic regions
- Specific stores
- Divisions or departments
For example, an athletic shoe company might report its profit margin for the company as a whole. To provide greater detail, it could report segment margins—the profit margins for different components of the business–such as women's shoes, men's shoes, children's shoes, and athletic accessories. If the company has multiple locations, it could also report the segment (geographic) margins for its Seattle stores, Chicago stores, and Philadelphia stores.
If it appears as if one business segment is doing exceptionally well and driving positive performance while the rest of the company is struggling, this might affect how analysts view the company and its valuation. Its valuation might be lower compared to another company, where the gross margins are equal but driven evenly by all business segments. The valuation of a company with only one high-performing segment might be even further compromised if that segment is expected to shrink in the future due to technological shifts or other headwinds.
Segment margin should be calculated for several periods to determine if there is a profitable trend or underperforming segments that need to be addressed.
Calculating Segment Margin
The segment margin formula is segment revenue minus segment expenses, whereby only the variables directly tied to the segment are included. In other words, corporate overhead would not be included in segment margin since it is not directly involved in generating revenue or expenses for a particular segment.
For example, let's say a company generated the following numbers:
- Segment revenue: $10 million
- Segment cost of goods sold (or cost of sales): $6 million
- Segment Profit: $4 million
If a manager wanted to show segment margin as a percentage, we would calculate it as ((segment revenue - segment expenses) / segment revenue)) * 100.
Using our example above, the segment margin would be: ($10 million - $6 million) / $10 million = .40 or 40% (.40 * 100 to represent it as a percentage).