The defensive internal ratio tells you how many days you can operate your business without needing to sell major assets or obtain extra financing. This number can be a critical tool in terms of safeguarding your business from financial threats. It lets you see exactly how long you can stay afloat without making changes, while also helping you identify when you need to make changes.
To calculate the DIR for your business, divide your current assets by average daily operating expenses. Your company’s current assets include cash, receivables, and things you can quickly convert to cash, such as stocks and bonds. Receivables refers to the money that customers owe your company.
To calculate your company’s average daily operating expenses, add up the bills it pays on a monthly basis, such as rent, wages, and utilities. Then, divide that sum by 30 to get your average daily operating expenses.
For example, say your business has $10,000 in cash, $15,000 in stocks and bonds, and $5,000 in receivables. Totaling those amounts results in current assets of $30,000. Now, to calculate daily operating expenses, imagine your business has average monthly operating costs of $6,000. Dividing $6,000 by 30 results in $200, which is your average daily operating expenses. When you divide $30,000 (your current assets) by $200 (your daily operating expenses), you get a DIR of 150.
What Your Company’s DIR Indicates
What does that number tell you? Again, it indicates the number of days your business can operate without needing to take additional measures to increase your current assets or decrease your operating costs. If you just keep doing business as usual, your business will run out of money to pay the bills after 150 days. In other words, as long as your clients pay their outstanding invoices, you can survive for nearly half a year, even if you don’t collect any new revenue.
Is 150 days good or bad? DIR, like other liquidity ratios, varies greatly between companies and situations, so it’s best to look at DIR trends in your business and your industry, rather than merely the standalone DIR value. For instance, if you track DIR regularly, you can see if your company’s DIR decreases over time. That shift could be a cause for concern, and it’s a good idea to figure out why that’s happening.
Although an increasing DIR is often a good thing, that too depends on the situation. It could indicate that excess cash is building up, and you could be using that money to grow your business. That said, keeping plenty of cash available is often recommended when you’re starting or operating a new business.
In addition to tracking your DIR, consider asking your accountant to provide you with other financial ratios for your business on a regular basis. Accountants usually have the ability to generate brief reports showing useful ratios, and your accountant can probably even provide reports that show how your company’s financial ratios trend over time. These are great tools for keeping tabs on your company’s financial performance.