Defensive Interval Ratio (DIR) is one of the most important ratios in judging the liquidity of the company. Defensive Interval Ratio is a ratio which explains how many days a company can operate without using its noncurrent assets, any long term asset or any other financial resources. Let us look at the above chart. Apple has a Defensive interval ratio of 4.048 Years, while Walmarts Defensive Interval Ratio is 0.579 years. Why there is such a big difference between the two? Does this mean that Apple is better placed from the liquidity point of view?

In this article, we will look at Defensive Interval Ratio (DIR) in detail.

• What is Defensive Interval Ratio?
• Defensive Interval Ratio Formula
• Interpretation of Defensive Interval Ratio (DIR)
• Defensive Interval Ratio Example
  • Example # 1
  • Example # 2
  • Example # 3
• Colgate – Calculating Defensive Interval Ratio
• Sector Defensive Interval Ratio
  • #1 – Communication Equipment – Defensive Interval Ratio
  • # 2 – Discount Stores – Defensive Interval Ratio
  • #3 – Internet & Content – Defensive Interval Ratio
  • #4 – Oil & Gas E&P – Defensive Interval Ratio
  • #5 – Restaurant – Defensive Interval Ratio
• Limitations of Defensive Interval Ratio
• In the final analysis

What is Defensive Interval Ratio?

Defensive Interval Ratio (DIR) is an interesting ratio to be considered. If you, as an investor, would ever want to know how a company is doing in terms of liquidity, Defensive Interval Ratio should be the one ratio you should rely upon.

Defensive Interval Ratio is a ratio which explains how many days a company can operate without using its noncurrent assets, any long term asset or any other financial resources. For example, if ABC Company has a DIR of 45 days, that means ABC Company can operate for 45 days without touching the noncurrent assets or long terms assets or any other financial resources. Many call Defensive Interval Ratio (DIR) as financial efficiency ratio, but it is commonly considered as “liquidity ratio”.

Defensive Interval Ratio (DIR) is a variation of quick ratio. Through DIR the company and its stakeholders get to know for many days it can use its liquid assets to pay its bills. As an investor, you need to have a glance at the DIR of a company for a long period of time. If it’s gradually increasing, it means the company is able to generate more liquid assets to pay for day to day activities. And if it’s gradually declining, that means the buffer of liquid assets of the company is gradually declining too.

To compute Defensive Interval Ratio (DIR), all we need to do is to take out the liquid assets (that are easily convertible into cash) and then divide it by average expenditure per day. In the denominator, we cannot include every average expense as that may not be getting used in the day to day activities. And on the numerator, we can only put items that are easily convertible in cash in short term.

In simple terms, go to the balance sheet. Look at the current assets. Select the items that can easily be converted into cash. Add them up. And then divide it by the average daily expenditure.

Other Liquidity Ratios Related articles – Current Ratio, Cash Ratio, Current Ratio vs Quick Ratio

Defensive Interval Ratio Formula

Let’s look at the Defensive Interval Ratio (DIR) formula.

There are two parts of this formula. First, we need to look at the numerator and then we will see how to compute the denominator.

Here’s the formula –

Defensive Interval Ratio (DIR) = Current Assets / Average Daily Expenditures

Now the question is what we would include in the current assets.

We need to take only those items that are easily converted into cash or equivalent. There are three things we would generally include in the numerator –

Current Assets (that can be converted into liquidity easily) = Cash + Marketable Securities + Trade Accounts Receivable

We have included these three because they can be easily converted into cash.

Also, checkout these articles on Current Assets – Cash & Cash Equivalents, Marketable Securities, Accounts Receivables

Now let’s look at the denominator.

The easy way to find out average daily expenditures is to first note the costs of goods sold and annual operating expenses. Then we need to deduct any non-cash charges like depreciation, amortization etc. Then finally we will divide the figure by 365 days to get the average daily expenditures.

Average Daily Expenditures = (Cost of Goods Sold + Annual Operating Expenses – Noncash Charges) / 365

Defensive Interval Ratio is considered to be the best liquidity ratio by many financial analysts. Most of the liquidity ratios like quick ratio, current ratio assess the current assets with current liabilities. And thus, they are unable to produce an accurate result about liquidity. In the case of Defensive Interval Ratio (DIR), the current assets are not compared to current liabilities; rather they are compared to expenses. Thus, DIR is able to produce almost an accurate result about the liquidity position of the company.

But there are few limitations as well which we will discuss at the end of this article. So the idea is to compute DIR along with quick ratio and current ratio. It will give the investor a holistic picture of how a company is doing in terms of liquidity. For example, if Company MNC has huge expenses and almost no liabilities whatsoever, then the DIR value would be drastically different than the value of quick ratio or current ratio.

Interpretation of Defensive Interval Ratio (DIR)

While interpreting the result you get out of DIR calculation, here’s what you should consider going forward –

• Even if Defensive Interval Ratio (DIR) is the most accurate liquidity ratio you would ever find, there is one thing that is not being noted by DIR. If as an investor, you are looking at DIR to judge the liquidity of the company; it would be important to know that DIR doesn’t take into account the financial difficulty the company faces over the period. Thus, even if the liquid assets are enough to pay off the expenses, it doesn’t mean the company is always in a good position. As an investor, you need to look deeper to know more.
• While computing the average daily expenses, you should also consider taking into account the cost of goods sold as part of the expenses. Many investors don’t include it as part of the average daily expense which ushers in a different resultant figure than the accurate one.
• If the DIR is more in terms of days, it is considered healthy for the company and if the DIR is less, than it needs to improve its liquidity.
• The best way to find out liquidity about a company may not be Defensive Interval Ratio. Because in any company, every day the expenditure is not similar. It may so happen that for few days there are no expenses in the company and suddenly one day the company can incur a huge expense and then for a while, there would be no expense again. So to find out the average, we need to even out the expenses for all the days even if there are no expenses incurred on those days. The ideal thing to do is to take a note of every expense per day and find out a trend where these expenses are repeatedly incurred. This will help to understand the liquidity scenario of a company.

Defensive Interval Ratio Example

We will look at few examples so that we can understand DIR from all angles. Let’s get started with the first example.

Defensive Interval Ratio Example # 1

Mr A has been investing in businesses for a while. He wants to understand how Company P is doing in terms of liquidity. So he looks at Company P’s financial statements and discovers the following information –

Particulars of P Company at the end of 2016

Details	2016 (In US $)
Cash	30,00,000
Trade Receivables	900,000
Marketable Securities	21,00,000
Average Daily Expenditure	200,000

How would he find almost an accurate picture of Company P’s liquidity?

This is a simple example. Here we need to compute Defensive Interval Ratio (DIR) by applying the formula straight since all the information is already given.

The formula of DIR is –

Defensive Interval Ratio (DIR) = Current Assets / Average Daily Expenditures

Current Assets include –

Current Assets (that can be converted into liquidity easily) = Cash + Marketable Securities + Trade Accounts Receivable

Let’s calculate the DIR now –

Details	2016 (In US $)
Cash (1)	30,00,000
Trade Receivables (2)	900,000
Marketable Securities (3)	21,00,000
Current Assets (4 = 1+2+3)	60,00,000
Average Daily Expenditure (5)	200,000
Defensive Interval Ratio (4/5)	30 days

After the calculation, Mr A finds that the liquidity position of Company P is not good enough and he decides to look into other aspects of the company.

Defensive Interval Ratio Example # 2

Mr B isn’t able to find the Balance Sheet of Company M. But he has the following information available with him –

Details	2016 (In US $)
Cost of Goods Sold (COGS)	30,00,000
Operating expenses for the year	900,000
Depreciation Charges	100,000
Defensive Interval Ratio	25 days

Mr. B needs to find the current assets of Company M which are easily convertible into cash.

We have been given the information for computing average daily expenditure and we know how to compute defensive interval ratio. By applying the information given above, we can find out the current assets of Company M which are easily convertible.

We will start with computing the average daily expenditure.

Here’s the formula –

Average Daily Expenditures = (Cost of Goods Sold + Annual Operating Expenses – Non cash Charges) / 365

So, let’s compute using the given information –

Details	2016 (In US $)
Cost of Goods Sold (COGS) (1)	30,00,000
Operating expenses for the year (2)	900,000
Depreciation Charges (3)	100,000
Total expenses (4 = 1 + 2 – 3)	38,00,000
Number of days in a year (5)	365 days
Average Daily Expenditure (4/5)	10,411

Now we will use the formula of DIR to find out the current assets which can easily be converted into cash.

Defensive Interval Ratio (DIR) = Current Assets / Average Daily Expenditures

Details	2016 (In US $)
Average Daily Expenditure (A)	10,411
Defensive Interval Ratio (B)	25 days
Current Assets (C = A * B)	260,275

Now Mr. B has got to know how much current assets of Company M can be converted into cash in short term.

Defensive Interval Ratio Example # 3

Mr. C wants to compare three companies’ liquidity position. He has furnished below the following information to his financial analyst to come to the right conclusion. Let’s have a look at the details below –

Details	Co. M (US $)	Co. N (US $)	Co. P (US $)
Cash	300,000	400,000	500,000
Trade Receivables	90,000	100,000	120,000
Marketable Securities	210,000	220,000	240,000
Cost of Goods Sold	200,000	300,000	400,000
Operating Expenses	100,000	90,000	110,000
Depreciation Charges	40,000	50,000	45,000

The financial analyst needs to find out which company is in better position to pay off the bills without touching any long term assets or external financial resources.

This example is a comparison between which company is in better position.

We will go step by step.

First, we will ascertain the total current assets which can easily be converted into cash. Then we would compute the average daily expenditure. Finally, we will find out the Defensive Interval Ratio (DIR).

Let’s get started.

Details	Co. M (US $)	Co. N (US $)	Co. P (US $
Cash (1)	300,000	400,000	500,000
Trade Receivables (2)	90,000	100,000	120,000
Marketable Securities (3)	210,000	220,000	240,000
Current Assets (4 = 1+2+3)	600,000	720,000	860,000

Now we will compute the annual daily expenditure.

Details	Co. M (US $)	Co. N (US $)	Co. P (US $)
Cost of Goods Sold (1)	200,000	300,000	400,000
Operating Expenses (2)	100,000	90,000	110,000
Depreciation Charges (3)	40,000	50,000	45,000
Total Expenses (4 = 1 + 2 – 3)	260,000	340,000	465,000
Number of days in a year (5)	365	365	365
Average Daily Expenditure (4/5)	712	932	1274

Now we can calculate the Defensive Interval Ratio and find out which company has better liquidity position.

Details	Co. M (US $)	Co. N (US $)	Co. P (US $
Current Assets (1)	600,000	720,000	860,000
Average Daily Expenditure (2)	712	932	1274
Defensive Interval Ratio (1/2)	843 days*	773 days	675 days

*Note: All of these are hypothetical situations and only used to illustrate DIR.

From the above computation, it’s clear that Co. M has the most lucrative liquidity position among all three.

Colgate – Calculating Defensive Interval Ratio

Now that we are familiar with the calculations of Defensive Interval Ratio of basic examples, let us calculate Defensive Interval Ratio for Colgate.

Step 1 –  Calculate Current Assets that can be converted into cash easily.

• Current Assets (that can be converted into cash easily) = Cash + Marketable Securities + Trade Accounts Receivable
• Colgate’s Current Assets contain Cash & Cash Equivalents, Accounts Receivables, Inventories and Other current assets.
• Only two items out of these four can be readily converted to cash – a) Cash and Cash Equivalents b) Receivables.

source: Colgate 10K Filings

• Colgate Current Assets (that can be converedt to cash easily) = $1,315 + 1,411 = $2,726 million

Step 2 – Find the Average Daily Expenditures

In order to find the average daily expenditure, we can use the following formula

Average Daily Expenditures = (Cost of Goods Sold + Annual Operating Expenses – Noncash Charges) / 365.

Here it is a bit tricky as we are not spoon fed with all the necessary information.

• From the Income Statement, we get the two items a) Cost of Sales b) Selling General and Administrative Expenses.
• Other expense is not an operating expense and hence excluded from the expenditure calculations.
• Also, the charge for Venezuela accounting in not an operating expense and is excluded.

source: Colgate 10K Filings

In order to find the non-cash, we need to scan the annual report of Colgate.

There are two types of non-cash items are included in Cost of Sales or Selling General & Admin expense.

2a) Depreciation & Amortization

• Depreciation and Amortization is a non-cash expense.  As per Colgate’s filings, Depreciation attributable to manufacturing operations is included in Cost of sales.
• The remaining component of depreciation is included in Selling, general and administrative expenses.
• The total Depreciation and Amortization figures are provided in the cash flow statement.

source: Colgate 10K Filings

• Depreciation and Amortization (2016) = $443 million.

2b) Stock-Based Compensation

• Colgate recognizes the cost of employee services received in exchange for awards of equity instruments, such as stock options and restricted stock units, based on the fair value of those awards at the date of grant over the requisite service period.
• These are called at Stock-Based Compensation. In Colgate, Stock-based compensation expense is recorded within Selling, general and administrative expenses in the Corporate segment.
• Since this is a non-cash item, we need to remove this too.

source: Colgate 10K Filings

• Stock-Based Compensation = $123 million

Average Daily Expenditure = (Cost of Sales + Selling General & Admin Expenses – Deprecation & Amortization – Stock Based Compensation – Restructuring Expneses)/365

Average Daily Expenditure = (6072 + 5249 – 443 – 123)/365 = 10755/365 = $29.46 million

Step 3 – Calculate Defensive Interval Ratio using the formula.

• Colgate Current Assets (that can be converedt to cash easily) =  $2,726 million
• Average Daily Expenditure = $29.46 million
• Defensive Interval Ratio = 2726/29.46 = 92.5 days.

Sector Defensive Interval Ratio

Let us now look at the Defensive Ratios of some of the sectors to understand if there is any common denominator between these companies.

#1 – Communication Equipment – Defensive Interval Ratio

Below table provides the details of Defensive Interval Ratio and Market Caps of top companies in Communication Equipments.

S. No	Company	Defensive Interval Ratio (years)	Market Cap ($ million)
1	Cisco Systems	4.2	171,870
2	Hewlett Packard	2.8	38,224
3	Nokia	1.9	29,997
4	LM Ericsson Telephone	3.0	21,085
5	Harris	2.4	13,828
6	Motorola Solutions	2.2	13,224
7	Juniper Networks	1.6	10,809
8	Zayo Group Holdings	0.5	7,587
9	CommScope Holding Co	1.4	7,238
10	EchoStar	2.3	5,293

source: ycharts

We note the following about Defensive Interval Ratios –

• On an average Defensive Interval Ratio of Communication Equipment companies is highers.
• Cisco has a defensive interval ratio of 4.2 years, while HP defensive ratio is at 2.8 years

# 2 – Discount Stores – Defensive Interval Ratio

Below table provides the details of Defensive Interval Ratio and Market Caps of top companies in Discount Stores.

S. No	Company	Defensive Interval Ratio (years)	Market Cap ($ million)
1	Wal-Mart Stores	0.58	222468
2	Costco Wholesale	1.32	77992
3	Target	0.82	37358
4	Dollar General	0.80	21369
5	Dollar Tree Stores	0.82	18746
6	Burlington Stores	0.54	6184
7	Pricesmart	1.52	2753
8	Big Lots	0.54	2330
9	Ollie’s Bargain Outlet	0.95	1949
10	Fred’s	0.79	674

source: ycharts

We note the following about Defensive Interval Ratio –

• Discount Stores have a defensive interval ratio of less than 1 years.
• Walmart has a defensive ratio of 0.58 years, while Costco Wholesale has a healthy defensive interval ratio of 1.32 years.

 #3 – Internet & Content – Defensive Interval Ratio

Below table provides the details of Defensive Interval Ratio and Market Caps of top companies in Internet & Content.

S. No	Company	Defensive Interval Ratio (years)	Market Cap ($ million)
1	Alphabet	3.11	572939
2	Facebook	2.45	391419
3	Baidu	2.58	60768
4	Yahoo!	2.53	43460
5	JD.com	1.74	42999
6	NetEase	4.60	39434
7	Twitter	2.30	11424
8	Weibo	1.82	10840
9	VeriSign	7.40	8589
10	Yandex	1.51	7588

source: ycharts

• Defensive Ratio of Internet Companies is very high.
• Verisign has an exceptionally high defensive interval ratio of 7.40 years.
• JD.com has the lowest defensive interval ratio at 1.74 years

#4 – Oil & Gas E&P – Defensive Interval Ratio

Below table provides the details of Defensive Interval Ratio and Market Caps of top companies in Oil & Gas E&P

S. No	Company	Defensive Interval Ratio (years)	Market Cap ($ million)
1	ConocoPhillips	0.67	58134
2	EOG Resources	0.30	55513
3	CNOOC	1.32	53738
4	Occidental Petroleum	1.50	49595
5	Anadarko Petroleum	0.61	36200
6	Canadian Natural	0.65	31809
7	Pioneer Natural Resources	1.69	31459
8	Devon Energy	0.21	22458
9	Apache	0.95	20265
10	Concho Resources	0.29	19747

source: ycharts

• Similar to discount stores, Oil & Gas E&P companies have a low defensive interval ratios.
• Devon Energy has the lowest DIR at 0.21 years.
• Pioneer Natural Resouces has the highest defensive interval ratio of 1.69 years.

#5 – Restaurant – Defensive Interval Ratio

Below table provides the details of Defensive Interval Ratio and Market Caps of top companies in Restaurant Sector.

S. No	Company	Defensive Interval Ratio (years)	Market Cap ($ million)
1	McDonald’s	2.62	105306
2	Starbucks	0.51	83771
3	Yum Brands	1.02	33726
4	Restaurant Brands Intl	5.82	13015
5	Chipotle Mexican Grill	1.44	12110
6	Darden Restaurants	1.02	9369
7	Domino’s Pizza	1.86	8977
8	Aramark	3.13	8820
9	Panera Bread	1.11	5258
10	Dunkin Brands Group	2.19	5028

source: ycharts

• Restaurant companies on an average have a healthy defensive interval ratio.

McDonalds has a DIR of 2.62 yeras, while that of Starbucks is a mere 0.51 years.

Limitations of Defensive Interval Ratio

Even if Defensive Interval Ratio (DIR) is the most dependable liquidity ratio of all, it still has few limitations. Let’s have a look at them –

• First of all, the cash receipts are mostly uneven. It may happen that the cash would be received in the next week and the investor is computing the Defensive Interval Ratio right now which would reduce the DIR as there would be less cash available to pay off expenses.
• Secondly, the cash and the accounts receivables are not always similar. They change regularly. Thus getting the right amount to compute DIR is difficult.
• Third, the expenses change drastically. And if at a particular date, DIR is calculated, the figure of that would be different than if the DIR is being calculated in the next week.

Recommended Reading – Ratio Analysis – Complete Guide

In the final analysis

Defensive Interval Ratio is useful but if it is being compared with other ratios as well. And the best way to find an accurate result is to try to look at the company’s liquidity on daily basis. If an investor takes the time and looks at all the accounting details, it may be feasible for him. But still, it would be a massive task. Thus, it’s better to do it quarterly or semi-annually and then by taking an average, the accuracy level of Defensive Interval Ratio could be improved.

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