What is Segment Contribution Margin

Segment Contribution Margin

In the world of financial markets, segment contribution margin is used as a way to determine the margin that will be required to sell a product.

The segment contribution margin is the margin that will be required to sell a product in the segments that are being analysed.

The segment contribution margin is a key factor in a company’s bottom line. It tells us if the company is earning a healthy profit from its segment or if it is losing money or just breaking even. It is crucial to identify a product or service that is under performing and figure out how to fix the segment. If a segment is unprofitable, it might not be a good idea to put any more money into it.

Computation of Segment Contribution Margin

A segment contribution margin is a segment’s sales revenue minus its direct costs (direct variable costs and direct fixed costs traceable to the segment). Such costs are assumed to be avoidable costs. An avoidable cost could be eliminated if management were to drop the segment.

If a segment has a positive segment margin—that is, the segment’s revenue is greater than its direct costs—it is able to cover its own direct costs and contribute a portion of its revenue to cover common costs and add to operating income. In that case, management should keep the segment.

If a segment has a negative segment margin, that is, the segment’s revenue is less than its direct costs management should eliminate the segment. However, certain common costs will be incurred regardless of the decision. Those are unavoidable costs, and the remaining segments must have sufficient contribution margin to cover their own direct costs and the common costs.

An analysis of segment profitability includes the preparation of a segmented Income statement using variable costing to Identify variable and fixed costs. The fixed costs that are traceable to the segments are called direct fixed costs. The remaining fixed costs are common costs and are not assigned to segments.