As a business owner or manager, you already know the importance of having an accurate financial statement. One of the essential statements is the segment margin income statement, which helps you determine the profitability of each segment of your business. In this article, we will discuss some tips and tricks to prepare a segment margin income statement.
What is a Segment Margin Income Statement?
A segment margin income statement is a financial statement that shows the profitability of each segment of a business. It helps you determine which segments are profitable and which ones are not. It is a useful tool for making decisions about the allocation of resources and investments.
Steps to Prepare a Segment Margin Income Statement
1. Identify Your Business Segments
The first step in preparing a segment margin income statement is to identify your business segments. A segment can be a product line, a geographic area, or a customer group. You should choose segments that are significant to your business and have distinct characteristics.
2. Determine the Revenue and Cost of Each Segment
Once you have identified your business segments, you need to determine the revenue and cost of each segment. You can use accounting software to track the revenue and cost of each segment or allocate the expenses based on some relevant allocation criteria.
3. Calculate the Segment Margin
The next step is to calculate the segment margin, which is the revenue minus the direct cost of each segment. Direct cost includes the cost of goods sold, direct labor, and direct materials. The segment margin tells you how much profit each segment is generating.
4. Include Indirect Costs
After calculating the segment margin, you need to include indirect costs that are not directly related to any specific segment, such as rent, utilities, and administrative expenses. You can allocate the indirect costs based on some relevant allocation criteria, such as the square footage of each segment.
5. Calculate the Operating Income of Each Segment
Once you have included the indirect costs, you can calculate the operating income of each segment by subtracting the indirect costs from the segment margin. The operating income tells you how much profit each segment is generating after considering all the costs.
Tips and Tricks
1. Use Relevant Allocation Criteria
When allocating expenses to each segment, make sure to use relevant allocation criteria that accurately reflect the cost drivers of each segment. For example, if you have two segments with different levels of sales, you should allocate the sales-related expenses based on the sales of each segment.
2. Review Your Segments Regularly
As your business evolves, your segments may change. It is essential to review your segments regularly and make adjustments as necessary. You may need to create new segments or merge existing ones to better reflect the nature of your business.
3. Compare Your Segments to Industry Benchmarks
To better understand the profitability of each segment, you should compare them to industry benchmarks. This will help you identify areas where you are doing well and areas where you need to improve. You can use industry reports, trade associations, or other sources to obtain industry benchmarks.
4. Use Your Segment Margin Income Statement to Make Better Decisions
The segment margin income statement is a powerful tool for making better decisions about your business. You can use it to identify profitable segments that you should invest in and unprofitable segments that you should consider divesting. It can also help you allocate resources more effectively.
Preparing a segment margin income statement is a crucial step in understanding the profitability of your business segments. By following the tips and tricks discussed in this article, you can prepare an accurate and useful segment margin income statement that will help you make better decisions about your business. Remember to review your segments regularly and compare them to industry benchmarks to stay ahead of the competition.