Large companies use segmented financial statements for both internal management reporting and external financial reporting. Segments are sections of a business managed and reported on separately. Segments can be geographic, profit centers or products or services. Analyzing a company's performance by individual segments can give managers greater insight into the relative profitability of different parts of the business.
What are Segmented Financial Statements?
Segmented financial statements split a company's books into reporting units. Each company has its own reporting units, which the company may segment based on where the operations are in the world or the kind of product or service is sold. An example of the first type of segmentation is reporting by continent. A company may want to analyze its North American and European units separately to see how profitable each is. An example of the second type of segmentation is a company that makes diapers and incontinence products. Each product has a separate cost structure, a separate marketing direction and a different target market.
Who Uses Segmentation?
Managers use segmented financial statements to help in the financial analysis process. Generally accepted accounting principles dictate that, if a company uses segmented reporting internally, it must also report segments externally to creditors and investors. This allows external financial statement users to look at the company the same way as managers can. Even small companies can benefit by reporting segments internally. Each segment represents a different profit potential and the more carefully and separately they are analyzed, the more information managers will have to increase profits in the future.
One of the most common segmentation method used by companies is geographic. Geographic units can be large or small. An international company may report on a country-by-country basis while a small home-based business might report on sales in different neighborhoods of the city. A geographic segment is not related to size, but to individual sales strategies. Another common segment is products and services. A lawn care company that has several services such as residential maintenance, commercial lawn cutting and landscape design may wish to look at the income and expenses related to each of those units to decide if it should continue offering all of the services.
The requirement to report segments externally can be a detriment to a company. It allows competitors significant insight into how the company operates and its individual profit margins. A company could lose competitive advantage by offering up details on what makes it the most money. In addition, external segmented accounting must follow generally accepted accounting principles while internal reporting may make more sense on a different basis. Many companies stick with the external format for their internal reporting to avoid having to create two different sets of financial statements. This can result in the managers not getting the kind of information they really need.