What is Segment Margin?
Segment margin is a profitability measure that assesses the profit or loss generated by a particular product, line of business, or geographic location. The segment margin is mainly used to compare the profitability of the different components of a company. The measure is extremely helpful for large companies with several business lines or maintains a presence in numerous geographic regions.
From the analysis of the segment margins, the company’s management may identify the strengths and weaknesses of each business component. The analysis of segment margins can be helpful even if the company is profitable overall. In such a case, the company may address the issues of the business segments with lower-than-average profitability or whose profitability experienced a significant decline relative to the past.
Undoubtedly, segment margins analysis is quintessential for the management’s decision-making as it helps to evaluate past management decisions, as well as provides the opportunity to identify major operating problems within different segments of the company.
Most of publicly-traded companies disclose their financial results according to the business segments and geographic locations. The information is disclosed on the company’s reports or regulatory filings (e.g., 10-K).
Formula for Segment Margin
The segment margin is calculated using the following formulas:
The revenues and costs used in the calculation of the segment margin should be attributable to the segment. It is not recommended to include costs traceable to corporate expenses since the costs are usually irrelevant to the operations of a segment. The inclusion of the corporate costs will distort the calculations of the segment margin and the conclusions drawn from the measure.
Example of Segment Margin
Orange Inc. is a technology company that produces two main products: smartphones and laptops. The table below is the summary of the company’s financial results broken down by products:
Due to the intense competition in the market, the company decided to improve its operations by investing in one of the product lines. To choose the most suitable product line, the management chose to evaluate the segment margins of its different product lines.
Based on the company’s segment analysis, it is obvious that the smartphones offer a much larger segment margin (42%) than the laptops (20%). The investments in the smartphone product line is a better option than investing in the laptop product line because the former will generate larger profits for the company.
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