Defensive Interval Ratio (DIR)

Did you know?

Pro members can track their course progress and get access to exclusive downloads, quizzes and more!

Find out more

Already got an account? Log in here.

Defensive interval ratio (DIR), also known as the defensive interval period (DIP) or basic defense interval (BDI), determines how many days a company can keep operating. It would need to use strictly its liquid or defensive assets without experiencing financial difficulty.

DIR is a helpful metric for assessing a company’s liquidity risk. Using defensive assets makes sure that the ratio represents the most modest but real-world scenario of the company’s liquidity. The company’s ability to carry on just relying on its liquid assets speaks of its financial strength.

It also demonstrates ability to survive organically, that is, without external help. Therefore, a high DIR is deemed good. But it still needs to be understood more holistically instead being a singled out as an indicator of a company’s financial health.

A company can keep track of its Defensive Interval Ratio regularly throughout the business cycle to know its liquidity situation at various periods. Several businesses are cyclical throughout a year or economic cycle. For instance, in the tourism sector, customers may book their trips during the first quarter of the year but not go on those trips until later in the year during the holiday season.

During the booking season, a company may get plenty of cash. But its actual state is dictated by customers actually going on those holidays. Therefore, during the booking season, income can be very low, and companies may have to get by with operations using their own means.

However, when holiday season comes in, they company begin to rake in revenue for the bookings. In any case, it is crucial to measure a company’s liquidity during this period and in comparison to data from earlier years.

Defensive Interval Ratio Formula

DIR = \dfrac{Current\: Assets​}{Daily\: Operational\: Expenses}

In this formula, current assets refers to the sum total of a company’s cash, marketable securities, and net receivables. For several analysts, the DIR formula is more accurate than that the classic quick ratio or current ratio formula because it considers a company’s short-term liquidity against its everyday costs. As well, the DIR offers analysts a view of a company’s liquidity over a certain period, instead of being just an assets-to-liabilities ratio.

This makes the DIR easier to explain as a liquidity ratio. People can more readily grasp a company’s liquidity by knowing how many days it can survive without using its long-term assets, as oppose to being told that the company has a quick ratio higher than one.

Even so, the defensive interval ratio alone cannot offer enough context regarding the company’s financial situation. The ratio must be compared with the figures of similar companies in the same industry before any insights on the company’s relative fiscal performance can be gleaned. Additionally, a current DIR can be compared to earlier DIR’s of the company to detect trends.

Defensive Interval Ratio Example

CARVE Inc. is going through a cyclical decline in the furniture manufacturing industry, and management would like to assess the company’s capacity to maintain operations at its current expenditure. Looking into its records, it finds that it has Daily Operational Expenses totaling $ 207,750; cash amounting to $1,600,000; marketable securities worth $5,550,000; and net receivables of $ 6,150,000. Based on these figures, the company’s total Current Assets can be calculated at $13,300,000. What is CARVE Inc.’s Defensive Interval Ratio?

Let’s break it down to identify the meaning and value of the different variables in this problem. 

  • Defensive Interval Ratio: unknown
  • Current Assets: 13,300,000
  • Daily Operational Expenses: 207,750

Now let’s use our formula: 

DIR = \dfrac{Current\: Assets​}{Daily\: Operational\: Expenses}

We can apply the values to our variables and calculate the defensive interval ratio:

DIR = \dfrac{13{,}300{,}000​}{207{,}750} = 64\: days

In this case, CARVE Inc. would have an Defensive Interval Ratio of 64 days.

The ratio indicates that CARVE Inc. has enough cash to keep operating for the next 64 days, but this number is still too close to the cash payment expected within two months. This makes it smart for the company to avoid all non-essential expenses to maximize its available funds until conditions are safer.

Defensive Interval Ratio Analysis 

The exact length of time a company can survive on its existing assets can never be determined, but analysts want to know the DIR to catch a downtrend in the ratio, indicating that a company’s liquid asset buffer is declining with respect to its current expenditure.

In general, a higher DIR is more favorable because it means the company is more liquid. Too much liquidity, however, can harm the company in that it could indicate capital not being used efficiently to generate bigger profits. Also, analysts must examine this ratio with respect to the company’s specific industry.

In capital intensive industries, for example, a company has to make large scale investments and reap long-term value. In others, running operations on short-term loans (for example, working capital loans) may be the norm simply because it is less expensive. Analysts have to understand all these factors before interpreting a company’s DIR.

Lenders also also known to check this ratio from time to time. While no covenant may be directly linked to this ratio, it is an accurate reflection of a company’s operating state.

However, analysts have to use the data points for this ratio very carefully. Many issues could arise in terms of receivables and expenditure. For instance, a company may not make any significant cash outlays for a number of days or even weeks, followed by a large cash payout to be made at once. The same is true for receivables.

The DIR is often used alongside other financial ratios, like the current ratio, to assess the fiscal health of a company. A company may have considerably different DIR and current ratio values if, for example, it has a huge expenditure but not so much debt.

Overall, the DIR is an important liquidity metric that gives a clear view of a company’s financial health, but analysts must use it carefully to make it truly useful.

Defensive Interval Ratio Conclusion

  • The defensive interval ratio reflects the number of days a company can keep operating using strictly its defensive or liquids.
  • This formula requires two variables: current assets and daily operational expenses
  • The DIR is usually expressed in the number of days.
  • This principle measures of how long a company can last using only or liquid assets without encountering financial difficulty.
  • A company’s expenditures and receivables can be highly unpredictable.

Defensive Interval Ratio Calculator

You can use the defensive interval ratio calculator below to quickly determine the number of days a company can keep operating using its defensive or liquid assets alone, by entering the required numbers.