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Defensive Interval Ratio

A liquidity ratio that uses daily operational expenses

What is the Defensive Interval Ratio?

The defensive interval ratio (DIR), also known as the basic defense interval ratio (BDIR) or the defensive interval period ratio (DIPR), is a financial liquidity ratio that indicates for how many days a company can operate without needing to tap into capital sources other than its current assets.

Such sources of capital include long-term assets such as a company’s patents or PP&E investments, which have relatively poor liquidity,  meaning that they would take considerably more time to sell off at their fair market value than the company’s current assets.

 

Defensive Interval Ratio

 

Typically, long-term assets cannot be sold in the current accounting period, and they usually take upwards of one year to liquidate. Another example of long-term capital would be the company’s external sources of capital that would also require more time to see cash flows from (i.e., issuing new debt or equity).

The key difference between the defensive interval ratio and other ratios is that the DIR does not compare the company’s current assets to its current liabilities. Rather, it compares the company’s current assets to the company’s daily cash expenditures.

As a result, many analysts believe that it is a better ratio to utilize when assessing the liquidity of a specific company. The ratio is also labeled “defensive” since it incorporates the company’s current assets, which are also called defensive assets.

 

How to Calculate the Defensive Interval Ratio?

The defensive interval ratio can be calculated by dividing the company’s current assets by its daily expenditures, as indicated below:

 

Defensive Interval Ratio

 

Where:

Current Assets = Cash + Accounts Receivable + Marketable Securities

Daily Expenditures = (Annual Operating Expenses – Non-cash Charges) / 365

Many analysts believe that the defensive interval ratio is a better liquidity ratio to use than the classic quick ratio or current ratio. It is because the latter ratios measure the company’s short-term liquidity with regards to its daily expenditures rather than some form of liabilities.

The formula will also provide a number of days, rather than a ratio of the company’s assets to liabilities, which makes it easier to interpret as a measure of liquidity. It would be more useful to understand that a company has the ability to remain liquid without tapping into its long-term assets for X number of days rather than knowing that a company has a quick ratio that is greater than one.

That being said, the defensive interval ratio, by itself, is not as useful as it could be, since it does not provide siginificant context about the company’s situation. Therefore, the ratio should be compared to the defensive interval ratio of comparable companies n the same industry in order to gain insight about how the company is performing relative to its competitors. The DIR can also be compared to the company’s very own historical DIRs in order to see how its liquidity had changed over time.

 

Defensive Interval Ratio Example

Suppose that a company currently has $40,000 in cash, $10,000 in accounts receivable and has $20,000 worth of available for sale securities. We also learn that the company has $300,000 in annual operating expenses and incurs $25,000 in annual depreciation. What is its defensive interval ratio?

 

Defensive Interval Ratio

 

Using the equation above, we can see that this company has a DIR of 92.9 days. As always, this number does not mean much by itself and should be compared to company historical DIRs and competitor DIRs in order to draw additional insights.

 

Additional Resources

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To learn more about related topics, check out the following resources:

  • How to Calculate Debt Service Coverage Ratio
  • Current Portion of Long-Term Debt
  • IFRS Standards
  • Cash Flow Statement

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