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Defensive Interval Ratio

What is the Defensive Interval Ratio?

As part of financial analysis, it is important to look at the liquidity position of any company. This helps in understanding if the company is ready to meet any sudden short term obligations.

Defensive Interval Ratio or DIR, in short, is one of the most used liquidity ratio. It helps in understanding how defensive is the company in managing its daily cash expenses.

Defensive Interval Ratio meaning

Defensive Interval Ratio explains how many days a company can continue its operations by using only its current assets to meet its daily cash expenditure.

It helps in understanding if the company has a strong liquidity position. This will show the ability of the company to meet its cash expenditure without the need to tap other illiquid resources like property plant and equipment or long term investments.

It is called defensive because, only most liquid assets like cash & cash equivalent, marketable securities and receivables are considered. These current assets serve as a defense to meet daily cash expenses

Defensive Interval Ratio formula

The formula for the DIR is quite logical.

We take current assets in the numerator and daily cash expenditure in the denominator.

Current assets refer to only cash & cash equivalents, marketable securities and receivables.

Daily cash expenditure refers to the amount the company would require to make as part of its operation in cash. This is calculated for the whole year and it is divided by 365 to arrive at daily cash expenditure.

What is Daily Operating Expenses formula?

Now, daily cash operating expenditure can be calculated using many ways.

We will discuss two simple ways here.

1st Approach

Daily Cash Expenditure = [ Total expenses – ( Non operating + Non-cash expenses)]/365

2nd Approach

Daily Cash Expenditure = (Total operating expenses – Non-cash expenditure)/365

It is important to note that only actual cash expenditure has to be considered.

Any non-cash expenditure such as depreciation and amortization or unrealized fair value changes will not be considered.

Let us understand the formula with couple of examples.

Defensive Interval Ratio example

Let us look at our 1st example.

We take Company A and Company B for calculating DIR.

Values given in the examples below are in $ millions.

Consider the below-given income statement for both the companies.

Now, let us also take a look at Total Assets for both the companies.

To calculate Defensive Interval Ratio, we need

Cash + Marketable securities + Receivables
Daily cash expenditure

Let us calculate the numerator value for both the companies.

Company A

Cash and cash equivalent = $ 110
Marketable securities = $ 30
Receivables = $ 100
Total = $ 110+ $30 + $100 = $240

Company B

Cash and cash equivalent = $ 120
Marketable securities = $ 20
Receivables = $ 150
Total = $ 120 + $ 20 + $150 = $290

Now, coming to daily cash expenditure, let us calculate using 1st Approach In the above example, there are few non-operating and non-cash expenses viz.

Depreciation and amortization
Interest Expenses
Income Taxes

Hence, we should reduce them from total expenses while calculating DIR.

Hence,

Daily Cash Expenditure = (Total Expenses – (Non operating + Non cash expenditure)/365

Company A

Daily Cash Expenditure =[ $1,930 – ($600 + $400 + $30)] / 365 = 900/365 = 2.47

Company B

Daily Cash Expenditure =[ $2,160 – ($200 + $300 + $360)] / 365 = 1,300/365 = 3.56

Now that we know all the values, let us calculate DIR for both the companies.

Defensive Interval Ratio = Current assets / Daily cash expenditure

Company A = 240 / 2.47 = 97
Company B = 290 / 3.56 = 81

What it means that Company A can continue paying for its operating cash expenditure for 97 more days before it runs out of its core liquid assets.

After that, it may have to tap other non-current assets to continue paying its daily cash expenditure.

This serves as a better liquidity measure for any company.

Calculating the Ratio Practically using Excel

In our next example, let us calculate the DIR ratio for Walmart using Excel.

Download the template for Walmart using the below option.

Defensive Interval Ratio Template

5883

Financial Ratios

FREE

After you download, you will see the Consolidated Income Statement of Walmart .

Also, we have an extract of Total Assets from Balance Sheet of Walmart.

Let us calculate DIR for Walmart for the year ending 31 Jan 2019.

Current Assets

Cash & cash equivalent =$ 7,722
Marketable securities= $0
Receivables= $6,283
Total current assets= $14,005

For Daily cash expenditure, let us calculate using 2nd Approach

In the case of Walmart, Depreciation and amortization is a non-cash expenditure.

We need to reduce D & A from Total Operating Expenditure to arrive at Total Cash Expenditure.

Look at below workings

Daily Cash Expenditure = (Total Operating Expenditure – Non cash expenditure)/365

Total Operating expenditure= $ 4,92,448

Non Cash expenditure (D & A)= $10,678

Hence, Total Cash Operating Expenditure = $ 4,92,448 – $10,678 = $481,770

Once we further divide the value by 365, we get Daily Cash Expenditure of $ 1,320

Now that we know all the values, let us calculate DIR for Walmart.

Defensive Interval Ratio = Current assets / Daily cash expenditure

= $14,005 / $1,320 = 10.6 days

Walmart has a very low Defensive Interval Ratio of only around 11 days.

What it means that the company can continue paying for its operating cash expenditure for only 11 more days before it runs out of its core liquid assets.

After that, it may have to tap other non-current assets to continue paying its daily cash expenditure.

Walmart has a very low DIR because it is into the Retail Business which generally has a very high Daily Cash Expenses.

Nonetheless, DIR for Walmart of 11 days is not a great ratio as such.

In the same way, we can calculate ICR for Walmart for different years so that we can analyze the ratio in depth.

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How to Interpret the Defensive Interval Ratio?

As we have already understood, DIR indicates how liquid is the company when measured with only core liquid assets like cash & cash equivalents, marketable securities and receivables.
Generally high Defensive Interval Ratio is perceived as the company has significantly high current assets or very low daily cash expenditure. Here DIR>1.
Negative Defensive Interval Ratio or Lower Defensive Interval Ratio is seen as high daily cash expenditure or insufficient liquid assets to cover its daily cash expenditure. Here DIR <1.
If DIR is low, this indicates the company does not have very high liquid assets to meet its daily cash expenditure.
This is seen very cautiously since the company may have to tap other illiquid assets like long term investments, property plant and equipment, etc to continue paying its daily cash expenses.

Trend Analysis

Any financial ratios will not give a clear picture when analyzed on a stand-alone basis.

Hence trend analysis has to be performed for a particular ratio.

Let us look at how DIR has moved historically in the case of Walmart.

Source

As you can see, DIR in the case of Walmart has fallen moderately from 13 days to 11 days.

Although not a significant fall, the company is not able to increase the ratio.

This indicates the company is having high daily cash expenditure or low current assets.

Comparison with similar companies

It is also important to compare DIR of the company with other similar companies in the same industry.

This helps in understanding how is the company performing when compared to other competitors or industry as a whole.

Walmart vs Home Depot

Although the DIR for Walmart is in the range of 11 to 13 days.

Other companies in the industry also have a similar situation.

Look at DIR profile of Home Depot – a home improvement retailer ( supplies tools, construction products, and various similar services).

Home Depot and Walmart both have very low DIR when compared to companies like Amazon.

Also, there is no significant improvement as such in the ratio for both the companies. This indicates that the industry the companies are operating in generally requires high daily cash expenditure.

Unless the companies improve their liquid assets like cash or marketable securities, the ratio will not improve significantly.

Amazon

Amazon Inc is into e-commerce, cloud computing, digital streaming, and artificial intelligence and other similar business.

It is very interesting to note how Amazon has a high DIR of almost 100 days. Such a high DIR is a good indication of a strong liquidity position of the company.

When compared to companies like Walmart or Home Depot, Amazon appears to have high Liquid assets because of which DIR is relatively high ( See chart ! )

ExxonMobil

ExxonMobil is a US-based multinational Oil and Gas company.

Generally, oil and gas companies are into highly capital intensive businesses.

They typically have relatively high liquid assets and also lower daily cash expenditure.

In this case as ExxonMobil, the company has high DIR in the range of 35 to 50 days.

Facebook vs Google vs Microsoft

When you calculate Defensive Interval Ratio for tech-based companies like Apple, Facebook, Google (Alphabet) and Microsoft, you see a relatively very high DIR.

Apple

In the case of Apple, DIR is almost as high as 291 days.

Also, we can see that the company is able to increase the ratio significantly from 174 days in 2014 to 291 days in 2018.

The main reason for such a great increase is because Apple generates huge cash profits every year which increases its liquidity position.

Hence Further, the company has moderate daily cash expenditure.

Result of all these aspects, DIR for Apple increased significantly in the past 4-5 years.

Facebook

DIR for Facebook also is very high compared to other companies under discussion.

Also, the company is able to increase its liquidity position from 2014 to 2018.

The company has a very low daily cash expenditure.

Hence, the Defensive Interval Ratio for Facebook is in the range if 700 to 900 days.

But, there was an increase in daily cash expenditure in 2018 leading to fall in DIR to 668 days.

Nonetheless, such a high DIR clearly boosts the company’s liquidity position.

Microsoft

Similar to Facebook, even Microsoft has a relatively high DIR of almost 800 days.

The company kept its daily cash expenses under control while the current assets increased significantly.

This helped the company in achieving such a high Defensive Interval Ratio. The company maintained such a solid liquidity position, that DIR was almost 1000 days back in 2014.

Such a high DIR is a clear indication of a strong liquidity position in the market.

Important considerations

Below are few important aspects one must consider while analyzing any company using Defensive Interval Ratio

Current Assets: As already highlighted, only cash & cash equivalent, marketable securities and receivables have to be considered.
Other current assets like Inventory, prepaid expenses should NOT be considered.
Daily Cash expenditure: Companies at times have many other non-cash expenditures apart from Depreciation and amortization.
Fair Value adjustments through income statement is an example. Such expenses have to be excluded as these are non-cash expenses.
Non-recurring items: Only operating cash expenditure has to be considered while calculating DIR.
Any unusual or non-recurring cash expenditure may be adjusted to arrive at a more realistic daily cash expenditure value.