Companies use segment reporting to document the performance of different areas of the business. Some businesses are required to by national and international accounting standards. Others do it on their own to show which segments are performing to expectations and which are not. The advantages and disadvantages depend on how the information is used.
Separating Profitable Segments
The key advantage of segment reporting is transparency. For businesses that operate in different categories or geographic areas, segment reporting can reveal which areas are profitable and which are drains on the bottom line. If the segment reporting shows a business its overseas operations are more profitable than domestic operations, it could prompt a change in strategic direction. Done properly, it keeps managers from hiding unprofitable ventures.
Segment reporting also allows stakeholders to get a better sense of the fluctuations that might affect overall numbers. If a business reports much higher earnings than expected, for example, segment reporting shows where those earnings are coming from. A stakeholder can look at the same report to determine if the numbers are sustainable. It's designed to help investors better understand the business and its potential cash flow.
Emphasis on the Present
Segment reporting can place too much of a focus on short-term numbers. For example, a businesses might create a division just for its online work. That division could run a significant deficit before the right people and infrastructure are in place. If these losses are outweighed by the company's overall performance, they might not stand out on the financial statements. However, breaking out those numbers as a data point via segment reporting can lead to pressure to reduce those losses to enhance short-term earnings.
Segment reporting lends itself to data manipulation if the information is reported in the “through management’s eyes” style. This gives company leaders more discretion in how it determines how segments are constructed and what metrics are reported. Managers may group together businesses with different business models. It can also cherry-pick metrics to send the desired message to stakeholders. Losses in an Internet division, for example, could be grouped with an unrelated profitable business unit to paint a better picture of performance.
- a-wrangler/iStock/Getty Images