Segment Margin

Segment margin is the amount contributed by a segment towards common fixed costs and profit of a business. It equals the contribution margin of a segment minus traceable fixed costs i.e. fixed costs which can be traced to it.

Segment margin is a measure of long-run profitability of a segment, a separate business unit. It tells whether the segment is earning enough to cover its variable costs and such fixed costs which are avoidable if the segment is shut-down. If the segment margin is negative and it is not likely to get positive any time soon, it is better to close the segment because the resulting savings in fixed costs would be more than the loss of contribution margin from the segment’s products.

Formula

Segment Margin = Segment Contribution Margin – Traceable Fixed Costs

Traceable fixed costs are such fixed costs which are directly caused by the segment. These costs can be completely avoided if the segment is shut-down.

Segment contribution margin equals segment revenues minus segment variable costs. Hence, segment margin can also be calculated as follows:

Segment Margin = Segment Sales – Segment Variable Costs – Traceable Fixed Costs

Calculation of segment margin depends on definition of segment. Many businesses have departments which are organized based on markets they serve, and each department typically has multiple products. Each product has some associated variable costs and some of the fixed costs of the department are caused by that product. Other fixed costs can be traced to other products and some of the fixed costs are common. Similarly, if the segment is a business unit, its segment margin depends on contribution margin of all its products and such fixed costs which can be traced to the department (whether or not they can be traced to its products).

Example

Apollo Sports, Inc. manufactures cricket equipment. It has two departments: Professional and Consumers. Following table shows revenues and costs of each department. All figures are in millions USD.

Professional Consumers Common
Revenues 20.5 50
Variable Costs 10 40
Fixed Costs 3 5 3

Professional Department has two products: Clothing and Equipment whose revenues and costs are as follows:

Clothing Equipment Common
Revenues 4.5 16
Variable Costs 4 6
Fixed Costs 1 1 1

Calculate the segment margin for Professional and Consumers departments and identify whether both products of the Professional Department are profitable.

Solution

As shown below, both department have positive segment margins:

Segment Margin (Professional) = 20.5 - 10 - 3 = $7.5

Segment Margin (Consumers) = 50 - 40 - 5 = $5

Let’s work out the segment margin of Professional Department products:

Segment Margin (Clothing) = 4.5 – 4 – 1 = -0.5

Segment Margin (Equipment) = 16 – 6 – 1 = 9

As you can see, the Clothing product has negative segment margin. It means that the Professional Department can improve its profitability by discontinuing Clothing. It is because even though it will lose a contribution margin of $0.5 million, its savings in fixed costs of $1 million are far larger.

Written by Obaidullah Jan, ACA, CFA and last modified on

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