Defensive-Interval Ratio

Definition

The term defensive-interval ratio refers to a measure of the number of days a company can operate using only its current assets.  The defensive-interval ratio is considered a measure of liquidity, since it evaluates a company's ability to meet its financial obligations.

Calculation

Defensive-Interval Ratio = Defensive Assets / Daily Operational Expenses

Where:

  • Defensive Assets = Cash + Marketable Securities + Net Receivables
  • Daily Operational Expense = (Operating Expenses - Non Cash Charges) / 365

Note: Days is the unit of measure for this ratio.

Explanation

Liquidity ratios allow the investor-analyst, as well as creditors, to understand if a company will have difficulty meeting its financial obligations.  Also known as DIR, the defensive-interval ratio measures the number of days a company could operate using only its current defensive assets (cash, marketable securities, and net receivables).

The company's daily operating expenses are in the denominator of this ratio.  Typically, this value is found by taking the company's annual operating expenses, minus their non-cash charges, and dividing that value by the number of days in a year.  Non-cash charges include ordinary expenses such as depreciation, depletion, amortization as well as extraordinary items (one-time charges).

The defensive-interval ratio can be used by investor-analysts to supplement some of the more traditional liquidity ratios.  For example, the current ratio and quick ratio compare a company's relatively liquid assets to its liabilities, which are balance sheet items.  The DIR compares that same set of assets to the company's operating expenses, which comes from the income statement.  Taken together, these measures provide a broader perspective of the company's ability to meet it short-term financial obligations.

Example

Several creditors were evaluating the financial health of Company A following a release of their yearend financial statements.  The total operating expenses for Company A appear in the table below:

Revenue $7,569,000
Cost of Revenue $3,976,000
Gross Profit $3,593,000
Selling, General and Administrative Expense $1,576,000
Depreciation / Amortization $110,000
Research & Development $438,000
Total Operating Expense $6,100,000

While the table below contains a listing of Company A's current assets:

Cash & Equivalents $2,581,000
Short-Term Investments $756,000
Cash and Short-Term Investments $3,337,000
Total Receivables, Net $4,253,000
Total Inventory $3,864,000
Other Current Assets, Total $1,279,000
Total Current Assets $12,733,000

Using the information in the above tables, it's possible to determine Company A's defensive-interval ratio.  The first step is to determine their daily operational expenses:

= (Operating Expense - Non Cash Charges) / 365
= ($6,100,000 - $110,000) / 365, or $16,400

The defensive assets of Company A would be equal to:

= Cash + Marketable Securities + Net Receivables
= $2,581,000 + $756,000 + $4,253,000, or $7,590,000

From these two values, it's possible to derive Company A's defensive-interval ratio:

= Defensive Assets / Daily Operational Expenses

= $7,590,000 / $16,400, or 462 days

The investor-analyst would then compare the above value to that of companies in the same industry as Company A.

Related Terms

liquidity ratios, current ratio, quick ratio, current assets, operating expenses, depreciation, capital to labor ratio