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Does the operating margin factor in interest? According to Wikipedia, operating margin is defined as operating income/revenue. The operating income is the EBIT, so it doesn't take into account the interest the company pays.

Questions:

  • Why not consider the interest paid? After all a company could borrow massively and spike up it's revenue.
  • What is the idea behind not factoring in this interest?
  • Should a company's operating margin be considered by an investor?

migrated from quant.stackexchange.com Jan 25 '12 at 13:41

This question came from our site for finance professionals and academics.

  • Why was this migrated from "finance professionals and academics" to "personal finance and money"? That seems backwards. – user296 Feb 7 '12 at 18:01
  • I assume having this knowledge who help somebody evaluate the strength of a company they might invest in. – MrChrister Oct 28 '12 at 1:03
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The idea of using EBIT (earnings before interest and taxes) is to nullify the effects of financial policy and tax rates when comparing different companies because they can vary widely from one company to the next. By ignoring interest (financial policy) and taxes, it allows an analyst/manager/bank/etc to focus on the company's ability to turn a profit from it's operations. It makes comparing different companies more "objective" in a sense. EBIT has its shortcomings since is does not nullify accounting policy (which is why EBITDA is used, although even that's not perfect).

Also there is a big misconception in one of your questions:

"After all a company could borrow massively and spike up it's revenue".

This is not true. The cash a company borrows does not affect their net income. To get technical, it is a balance sheet transaction. Borrowing cash only affects accounts on the balance sheet (namely cash and debt). Eventually the interest expense will flow through to the bottom line, but the cash itself has no effect on net income. Only sales will increase revenue.

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I believe the operating margin is one of the most important fundamental figures for a company as it makes the company comparable over longer time horizons and among the industry, where companies usually have different financial structures. It is a true indicator of the companies operating performance. If you would add financial income, you would distort the result of the analysis as it is dependent on interest rates (which vary) and one-time effects.

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