What is Defensive Interval Ratio?
Defensive Interval Ratio is a liquidity ratio that measures the number of days a company can operate current quick assets can finance its daily cash expenditures assuming.
It is not expect to receive any cash inflows during the period without having access to non-current assets. Means, it will not have to depend on fixed assets or external sources of finance.
It measures company’s ability to finance its daily cash expenses out of its quick assets. In simple language, it estimates the quantity of days an organization can survive its day to day operations with its quick assets.
Defensive Interval Ratio or DIR may be a great way to search out out if the organization may be a good investment for you or not. Defensive Interval Ratio preferably called as Defensive Interval Period.
By definition, Defensive Interval Ratio is an efficiency ratio that measures how many days a company can operate without having to access non-current or long term assets.
To compute Defensive Interval Ratio (DIR), all we need to do is to take out the liquid assets (that are easily convertible into cash) and then divide it by average expenditure per day.
In the denominator, we cannot include every average expense as that may not be getting used in the day to day activities.
And on the numerator, we can only put items that are easily convertible in cash in short term.
Read| Debt to Equity Ratio
Advantage Defensive Interval Ratio
- It is an analyzing economic indicators and their use in current operations- preferably on a monthly basis.
- The great advantage of DIR, for those less familiar with the theory of finance, is the fact that this index is calculated in days. Because of this he is very suggestive.
- With the help this ratio, knowing the current value of the DIR and the emerging trend, and having its own preferences as to its expected value. Simply we can say, it is a trend of the indicator.
- It is in a comfortable situation, able to act on this basis to stabilize the DIR at the correct (expected) level.
Disadvantage Defensive Interval Ratio
- It is difficult to judge if the result is good or bad.
- This ratio does not yield an overly accurate view of exactly how long a company’s assets will support operations.
- Cash receipts tend to be just as uneven as expenditures
Formula Defensive Interval Ratio
Analysis and Interpretation Defensive Interval Ratio
While interpreting the result you get out of DIR calculation, here’s what you should consider going forward –
- Defensive Interval Ratio (DIR) is that the most accurate liquidity ratio you’d ever find, there’s one thing that’s not being noted by DIR. If as an investor, you are looking at DIR to judge the liquidity of the company.
- It would be important to know that DIR doesn’t take into account the financial difficulty the company faces over the period. Thus, even if the liquid assets are enough to pay off the expenses, it doesn’t mean the company is always in a good position. As an investor, you need to look deeper to know more.
- While computing the average daily expenses, you should also consider taking into account the cost of goods sold as part of the expenses. Many investors don’t include it as part of the average daily expense which ushers in a different resultant figure than the accurate one.
- If the DIR is more in terms of days, it is considered healthy for the company and if the DIR is less, than it needs to improve its liquidity.
- The best way to find out liquidity about a company may not be Defensive Interval Ratio. Because in any company, every day the expenditure is not similar.
- It seems for few days there are no expenses in the company. Suddenly, one day the company can incur a huge expense. After a while, there would be no expense again. So to find out the average, we need to even out the expenses for all the days. If there are no expenses incurred on those days.
- The ideal thing to do is to take a note of every expense per day. Find out a trend function where these expenses are repeatedly incurred. This will help to understand the liquidity scenario of a company.
Example Defensive Interval Ratio
Let’s say, Hardware Industries is suffering through a cyclical decline in the heavy equipment industry. Although, the cycle appears are to be turning up.
The company expects a cash-in-advance payment from a significant customer in 60 days. In the meantime, the CEO wants to know the power of the organization to remain in business at its current rate of expenditure.
The following information applies to the analysis:
Cash = $120000
Marketable securities = $370000
Trade receivables = $410000
Average daily expenditures = $13845
The calculation of the defensive interval ratio is:
($120000 Cash + $370000 Marketable securities + $410000 Receivables) / ($13845 Average daily expenditures)
= 65 days
The ratio reveals that the firm has sufficient cash to stay operational for 65 days. However, this figure is so near to the projected receipt of money from the customer.
So to eliminate all discretionary expenses are for the next few months. It is to extend the period over which remaining cash can be stretched.