A business normally has more than one segment which facilitates specialization in the specific area and results in increased efficiency and profitability. For example, an airline may have segments like domestic operations, international operations, freight operations, etc. while an automobile manufacturer may have segments like motor bikes, cars, trucks, SUVs, etc.
Segments are either a cost center, revenue center, profit center or investment center depending on the nature of their operations and the level of responsibility given to the segment management.
The central management provides the overall direction and strategy but a significant amount of decision making is delegated to the segment management. It is important to actively monitor their performance which is measured by management accounting tools such as residual income, return on investment, accounting rate of return, etc. By analyzing these metrics, the centralized management decides whether to put in additional investment in a segment based on its excellent performance or to divest from a segment when it is losing money.
These tools are also useful in comparing performance of different managers and in many businesses their remuneration is linked to the ROI or residual income they earn.
Written by Obaidullah Jan, ACA, CFA and last revised on