# Defensive Interval Ratio: Definition and How to Calculate?

The defensive Interval period or ratio is a liquidity measure of a business. It gives the idea of business’s ability to meet its operational expenses utilizing current assets. It offers insights on a business’s ability to meet the current expenses without the need for liquidation of long-term assets.

## What is Defensive Interval Ratio?

The Defensive period is the number of days a business can meet its expenses from current assets. As current assets are the first line of defense in liquidity crunch it’s named as a defensive interval period. It relates to liquidity because non-current or fixed assets take a longer time to convert into cash. Current assets including cash, receivables, marketable securities, and other saleable assets can be liquidated quickly.

## How to Calculate Defensive Interval Ratio?

Defensive interval ratio (DIR) is calculated as:

DIR = Current Asset ÷ Average daily operational expenses

Current Asset = Cash + Cash equivalents + marketable securities + receivables

Average Daily expenses = (Annual Operating expenses – non-cash charge)/365

Non-Cash Charge = Adjustment for non-cash items like Depreciation and Amortization.

Note: Average daily expenses can be calculated for any given period. Quarterly financial statements need to include all figures for 03 months only. Marketable securities and tangible assets with a readily available market should include in the current assets.

For quoted companies, the figures of current assets and average daily expenses are easily available from the published financial statements. The net change after non-cash items can be used directly, as all listed companies also publish a statement of cash flow.

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## Working Examples

Suppose a company Techno Green reports current asset details and daily operating expenses as below:

We can calculate the DIR by simply dividing its total current assets with its average daily expenses.

DIR = Current Asset ÷ Average daily operational expenses

DIR = (1,500,000 + 750,000+2,230,000) / (250,000)

Hence, DIR = 17.92 Days.

Let us consider a real-world example. Tesco’s is a leading retailer in the UK. It reports its financial statements annually (for 2020) with current assets and operating expenses as:

Total current Assets= £ 13,164 m      Including Cash and Cash Equivalents = £ 3,408 m

Total operating expenses = £ 59,871 m

Amortization and non-cash charges = £ 309 m

Average Daily Expenses = (59,871 – 309)/365 = £ 163.18 m

DIR = current assets ÷ average daily expenses

DIR = (13,164 ÷ 163.18) = 80.67 Days

For the Year ended 2019:

DIR  =       80.3 Days

## Interpretation and Analysis

The defensive interval ratio can be best interpreted with comparisons. In our working example, a giant retailer with large current assets enjoys a higher DIR of 80+ days. Moreover, its DIR for the year on year basis remained stable. Companies with a large number of current assets would enjoy a higher DIR. If a company can maintain the DIR it can be interpreted to be financially stable in the short-term. For a large entity like Tesco, a DIR of 80 days does not solely look a solid ratio. But as it is a retail business with large cash receipts it can sustain operational expenses with a lower average defensive period too.

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The defensive period merely states the company’s ability to meet day-to-day expenses from the current assets. It cannot be interpreted as the company’s total profitability or solvency. However, it offers useful information on the company’s needs for financing options with long-term assets.

While interpreting the DIR, it must follow the one-time and significant changes in operating expenses. Also, calculating the daily average on annual basis may not provide useful information for a rapidly changing business environment. Non-cash charges like depreciation and amortization are only covered periodically. Cash flow statements in conjunction with the expected defensive period should be analyzed.

A DIR can provide useful information on both liquidity and efficient utilization of current assets of a business. Analysts will use the daily expenses and current asset figures differently. Some marketable securities listed under the current assets section may not be readily convertible into cash within days. Calculations of average daily expenses may also differ. A financial year’s average expenses can be compared against assets convertible to cash up to one year. A better daily expenses average can be interpreted by dividing monthly expenses against current assets.

## Advantages of Defensive Interval Ratio

Defensive interval ratio provides useful information:

• The defensive interval ratio takes current and quick ratio analysis one step ahead by analyzing expenses against current assets instead of liabilities.
• It offers a realistic liquidity analysis as it removes non-cash charges with calculations.
• It provides critical information on a company’s short-term solvency in cash and liquidity terms.
• This ratio can provide insights on operating expense fluctuations if the DIR changes significantly over time.
• It offers valuable information on the company’s ability to efficiently utilize cash and cash equivalents.
• The company may decide on financing options with careful interpretation of the DIR.
• A consistent DIR means the company has maintained regular cash inflow and kept the expenses under control.
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## Limitation of Defensive Interval Ratio

With all the benefits and usefulness, the DIR also has some limitations:

• Calculation of average daily expenses can be tricky in the DIR formula
• Annual operating expenses may see one-time large variances affecting the analysis
• Non-cash charge and income from investing activities may also boost the DIR occasionally, which may be misleading for long-term analysis
• Cash and cash equivalents along with trade receivable calculations may not be straight forward and change significantly during the year.
• A ratio must be compared with industry standard or previous year performance to see a clearer picture.
• It may mislead the management to financing options with lower DIR due to sudden one-time changes in daily expenses.

## A Quick Wrap-Up

The defensive interval ratio provides useful analyses about a business’s ability to meet the daily operating expenses. If current assets and average daily expenses are adjusted for non-cash charges, it can provide useful information on liquidity. It provides important financial health information on a business’s need to go for additional financing. It must be interpreted and compared carefully, as it may lead to a risk-averse decision and increase the financing costs.

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