Defensive Interval Ratio

Defensive interval ratio is a liquidity ratio that measures the number of days for which the company's current quick assets can finance its daily cash expenditures assuming it is not expected to receive any cash inflows during the period. It is calculated by dividing quick assets by daily cash expenses.

A defensive interval ratio that is lower relative to industry average or to previous year's average raises alarm about liquidity problems unless there are sufficient expected cash inflows over the period.

Formula

Defensive Interval Ratio =Quick Assets
Daily Cash Expenses

Quick Assets = Cash + Marketable Securities + Receivables

Example

The following table summarizes information about three companies. Find their defensive interval ratio and tell which company is most likely to face serious liquidity problems. (All amounts are in million dollars.)

ABC
Cash203050
Marketable securities5025100
Receivables3003090
Prepayments020100
Inventories0130300
Daily cash expenses626
Daily cash inflows expected for next 2 months3021

Analyze the ratio assuming that the industry average defensive interval is 2 months.

Solution

ABC
Cash203050
Marketable securities5025100
Receivables3003090
Quick assets (A)37085240
Daily cash expenses (B)626
Defensive interval (A/B)61.742.540.0
Daily cash inflows expected for next 2 months3021

Company A's defensive interval is as much as industry average, so the company is just fine in the short-run.

Though Company B's defensive interval ratio is lower than the industry average, the company is expected to generate as much cash inflows as its cash outflows. Hence, it means it is not expected to face any significant liquidity problems.

Company C is expected to face problems because not only its defensive interval ratio is significantly lower than the industry, it's expected daily cash inflows over the period are much lower than its daily expected cash outflows. The company should either accelerate its cash inflows or arrange short-term borrowing.

Written by Obaidullah Jan, ACA, CFA <--- Hire me on Upwork