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.)
| A | B | C | |
|---|---|---|---|
| Cash | 20 | 30 | 50 |
| Marketable securities | 50 | 25 | 100 |
| Receivables | 300 | 30 | 90 |
| Prepayments | 0 | 20 | 100 |
| Inventories | 0 | 130 | 300 |
| Daily cash expenses | 6 | 2 | 6 |
| Daily cash inflows expected for next 2 months | 30 | 2 | 1 |
Analyze the ratio assuming that the industry average defensive interval is 2 months.
Solution
| A | B | C | |
|---|---|---|---|
| Cash | 20 | 30 | 50 |
| Marketable securities | 50 | 25 | 100 |
| Receivables | 300 | 30 | 90 |
| Quick assets (A) | 370 | 85 | 240 |
| Daily cash expenses (B) | 6 | 2 | 6 |
| Defensive interval (A/B) | 61.7 | 42.5 | 40.0 |
| Daily cash inflows expected for next 2 months | 30 | 2 | 1 |
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, CFAhire me at