Defensive interval ratio

Defensive interval ratio
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Methods and techniques

Defensive interval ratio (DIR, DIP, BDI) is a metric that describes how long the company can operate without access to noncurrent assets. It is a kind of liquidity index. In the literature it can be found also as:

  • defensive interval period,
  • basic defense interval.

The noncurrent assets are e.g. those that cannot be obtained in current accounting year. The current assets are:

  • cash
  • securities that can be sold on market
  • net receivables

The longer DIR is the better for liquidity. But too high DIR can indicate that the company doesn't invest in long-term, which can bring problems in future.

How to calculate defensive interval ratio?[edit]

The formula for defensive interval ratio is:

DIR (days) = current assets / daily operational expenses

If the daily operational expenses cannot be calculated based on current data, they can be predicted: annual operating expenses - noncash charges, all divided by 365 days.

Need and usability Defensive interval ratio[edit]

The Cash Safety Period indicator (DIR) is one of the most important indicators of the company's financial liquidity, informing about the company's ability to service its current liabilities. When analyzing economic indicators and their use in current operations, attention should be paid to the need for periodic analysis of indicators - preferably on a monthly basis. In this case, it seems that the application of quarterly periods completely exhausts the cognitive values of this measure and its more frequent use, although possible, seems not to be necessary. 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. Calculated for a given company, DIR informs how many days a company can operate thanks to the already possessed liquid assets, without the need to receive funds from the next period. The Management Board, knowing the current value of the DIR and the emerging trend, and having its own preferences as to its expected value, is in a comfortable situation, able to act on this basis to stabilize the DIR at the correct (expected) level.

The result from the above equation shows theoretically that a company can operate without the inflow of cash to the indicated number of days. It is difficult to judge if the result is good or bad. In order for such an assessment to become possible, more information is needed. First of all, it is good to know the trend of the indicator from calculations for earlier periods. Secondly, the management should have its own expectations in this respect and refer them to current calculations. Thirdly, it would be great to know the estimated value of DIR for the industry in which the company specializes in its area of influence.

The defensive interval ratio the most important things which can indicator able to indicate in statistical terms the method of measuring liquidity and indebtedness in an enterprise. (Blanchette M. 2012, p. 6-26).

References[edit]

Author: Paulina Pietroń