What is Defensive Interval Ratio (DIR)?
Defensive interval ratio used to measure the cash-based liquidity and determines the number of days a Company/Organization can operate without using non-current assets or other cash financial resources. The defensive interval is also known as the defensive interval period (DIP) or basic defense interval (BDI). Defensive Interval Ratio is sometimes considered as the financial efficiency ratio.
Defensive Interval Ratio (DIR) Formula
Defensive Interval Measure = Total Defensive Assets / Projected Daily Operating Expenditure
Breaking Down Defensive Interval Ratio
Defensive Interval Measure = No. of days (An organization can operate).
Total defensive assets = Cash, Short-term marketable securities and accounts receivable.
Daily operational expenses = (annual operating expenses – non-cash charges) / 365
Interpretation of Defensive Interval Ratio
Defensive assets consist of quick assets i.e., cash, short-term marketable securities and accounts receivables. Considering that the numerator is the total defensive assets, not the net and current liabilities are not deducted from the total. The ratio can be obtained by dividing the total defensive assets by the operating costs per day that could necessitate the use of resources that are defensive.
The best estimate for this figure will be the one according to the cash budget for the subsequent year. The cash budget of a company is, however, internal advice that’s unlikely to be accessible to the external analyst, who will consequently base his projections about the entire operating expenses in the income statement of the prior year. This amount will have to be corrected for expense items like depreciation etc., which do not need the use of defensive assets, and for known changes in the projected operations.
While assuming the liquid standings of a business, an analyst must examine some other information that is important for suitable evaluation like the existence of different liability and assets valuation procedures. The business even has revolving credit agreements with banks and this information may be available by way of footnotes to the statements.
Defensive Interval Measure Demonstration
As we know, defensive interval ratio is actually the measure of days to determine the liquidity of a company i.e., how many days a company can operate without using its non-current assets. In the above chart, Facebook has a defensive interval ratio of 2.296 years which means Facebook can operate almost 838 days without using its non-current assets. On the other hand, Amazon has a defensive interval ratio of 1.431 years that shows the ability of Amazon to stay operational for almost 522 days without using its non-current assets or any other financial sources.
Global Industries is facing a gradual decline in its heavy industries unit. Meanwhile, the company expecting an advance cash payment from a customer in the next 80 days. The Cheif executive officer (CEO) asks the analyst to determine the ability of the company to stay operational until the payment received. The following data is applied to analyze:
Cash = $1,400,000
Marketable securities = $3,500,000
Account receivables = $5,100,000
Average daily expenditures = $118,500
DIR = (Cash + Marketable Securities + Account Receivable) / Average daily expenditures
= (1,400,000 + 3,500,000 + 5,100,000) / 118,500
= 84 days
The above analysis reveals that the Defensive interval measure is 84 days i.e., unit is capable to stay operational for the next 84 days without using its non-current assets but there is a signal if the expecting payment gets late from 80 days, the unit will start using its non-current assets and other financial resources.