What is Defensive Interval Ratio (DIR)?
Defensive Interval Ratio (DIR), also known as Defensive Interval Period (DIP) or Base Defense Interval (BDI), is a financial metric that shows how many days a business can operate without the need for ” access non-current assets, long-term assets whose full value cannot be obtained during the current accounting year, or additional external financial resources.
Alternatively, this can be thought of as the length of time a business can operate relying only on liquid assets. The DIR is sometimes viewed as a financial efficiency ratio but is most often viewed as a liquidity ratio.
Key points to remember
- The Defensive Interval Ratio (DIR) seeks to calculate how many days a business can operate relying solely on liquid assets.
- Current assets are compared to daily expenses to determine the defensive interval ratio.
- The defensive interval ratio can be examined over time to determine whether a company’s liquidity buffer to meet its expenses is increasing or decreasing.
- Many analysts consider the Defensive Interval Ratio (DIR) to be more useful than the Quick Ratio or Current Ratio because it compares assets to actual expenses rather than liabilities.
- While a higher DIR number is preferable, there is no specific number that indicates what is fair or best to aim for.
Understanding the Defensive Interval Ratio (DIR)
The DIR is considered by some market analysts to be a more useful liquidity ratio than the Standard Quick Ratio or Current Ratio due to the fact that it compares assets to expenses rather than comparing assets to liabilities. The DIR is commonly used as a supplemental financial analysis ratio, along with the current or fast ratio, to assess the financial health of a business because there can be significantly different values of the DIR and the fast or current ratio if, for example, example, a business has a lot of expenses but little or no debt.
The DIR is called the defensive interval ratio because its calculation involves the current assets of a company, also known as defensive assets. Defensive assets are made up of cash, cash equivalents, such as bonds or other investments, and other assets that can be easily converted into cash such as accounts receivable.
For example, if a company has $ 100,000 on hand, $ 50,000 in marketable securities, and $ 50,000 in accounts receivable, it has a total of $ 200,000 in defensive assets. If the daily operational expenses of the company are equal to $ 5,000, the value of the DIR is 40 days: 200,000 / 5,000.
Of course, a higher DIR number is considered good because not only does it show that a business can rely on its own finances, but it also gives a business enough time to assess other meaningful options for paying its expenses. . That being said, there is no specific number that is considered the best or the correct number for a DIR. It is often helpful to compare the DIRs of different companies in the same industry to get a sense of what is appropriate, which would also help determine which companies might be better investments.
Formula for Defensive Interval Ratio (DIR)
The formula for calculating the DIR is:
DIR (expressed in number of days) = current assets / daily operating expenses
Current assets = cash + marketable securities + net receivables
Daily operating expenses = (annual operating expenses – non-cash charges) / 365
Benefits of Defensive Interval Ratio (DIR)
The DIR is a useful tool for assessing the financial health of a business because it provides a real-world measure in number of days. This way, a company knows exactly how long it can continue to operate while meeting day-to-day operational expenses without encountering financial difficulties that would likely require it to access additional funds through a new equity investment. a bank loan or the sale of long-term assets. This is extremely important in managing his financial health because he can manage his balance sheet before having to incur unwanted debts.
In this regard, it can be seen as a more useful liquidity measure to consider than the current ratio, which, while providing a clear comparison of a company’s assets versus its liabilities, does not give any definitive indication of how long it will last. during which a business can operate financially without encountering significant problems in terms of simple day-to-day operations.