Before you can start setting up departments, you must have at least one company in the system. Having your employee grouped into departments, will allow you easier to find employee in the Company Tree, you can generate reports for departments much faster, and you can assign permissions to some users which are limited to view/edit employees in a single department.
If you have large department and you want to further sub-divide it, you can create sub-departments. You can further create up to one level of Sub-Departments.
Sub-Departments are not available in Small Business Edition