Companies that sell a variety of goods and services often like to evaluate how different areas of the business are faring. A company can better evaluate performance if it breaks its activities into segments and calculates individual segment margins. Generally accepted accounting principles require a publicly traded company to report segment profits and losses separately if the segment's revenue, assets or net profit comprises 10 percent or more of the company's total revenue, assets or net profit.
1. Identify the Segment
Broadly speaking, a segment is a distinct portion of a business that has identifiable revenues and expenses. According to guidance provided by McGladrey, an international accounting firm, U.S. companies should identify segments based on products and services rather than geographical location. For example, say a company has locations in California, Texas and Washington and manufactures office supplies and furniture. It should create segments based on the production and sale of office supplies and furniture rather than segments for each state.
2. Identify Segment Revenues
Calculate the distinct revenues that the segment generates. For example, say a company has $1 million in revenue; $400,000 of the revenue is from the sale of pencils, pens and notepads, $500,000 is from the sale of couches and chairs and $100,000 is corporate investment revenue. In this example, $400,000 is the segment revenue for the office supply segment.
3. Identify Segment Expenses
Calculate the distinct expenses incurred by the segment. You can assign an expense to a segment if the segment manager had control over the expense or if the cost wouldn't have occurred if the segment didn't exist. Salaries, rent, utilities, marketing and taxes specifically for segment activity are all valid expenses. Corporate expenses such as CEO salary or rent for the corporate headquarters shouldn't be included in segment expense.
4. Calculate Segment Margin
To calculate the segment's operating margin, subtract segment expenses from segment revenues and divide this number by segment revenue. For example, if the office supply's revenue is $400,000 and its expenses are $100,000, its operating income is $300,000 and its margin is 75 percent. The higher the margin, the more profit the margin keeps relative to the amount of revenue that it brings in.