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How to Calculate Interval Ratio?
What is Interval Ratio?
The Interval Ratio or Interval Measure is the ratio that calculates the funds that a company required to run its operations. This ratio helps the companies survive by letting them know how much funds they will require for a particular project on a long-term basis.
In other words, the interval ratio measure shows the number of days that a company will survive with the funds it has in its hands.
The interval ratio can help a company plan for the future in advance. By knowing how long a company can run without accessing any other source of funding, the ratio offers the idea of the financial strength of the company. The interval measure also helps control and manage expenses by efficient use of assets so that a company can manage to run on the available resources for the longest period of time.
Companies usually tend to remain within the interval measure if no extreme situation occurs. In the case a company cannot ignore accessing new funds, it may access funds by pushing the interval measure higher. However, this is considered detrimental to the company’s financials.
Therefore, in order to avoid exceeding a certain limit of the ratio, a company may resort to cost-cutting measures or accept a lean operational procedure. Therefore, interval ratio is also known as the Defensive Interval Ratio.
Calculation of Interval Ratio
Interval Ratio is actually not that difficult to calculate. It is obtained by dividing liquid or quick assets by the average daily expenses of a company. Inventory should not be included in quick assets because it is hard to convert inventory into cash within a short span of time. This means the quick ratio is given by current assets minus the inventory.
However, if the inventory is convertible to cash within a certain duration of time, it may be included in quick assets.
Therefore, the interval ratio is given as follows −
$$\mathrm{\mathrm{Interval\: Ratio}\:=\:\frac{\mathrm{Quick\: or\: Liquid\: Assets}}{\mathrm{Daily\: Operational\: Expenses}}}$$
Example −
Suppose company A has the following figures −
Cash and Cash Equivalents = Rs 50 Crores
Marketable Securities = Rs 25 Crores
Accounts Receivables = Rs 25 Crore
Average Daily Expenses = Rs 2 Crores
Therefore, the Interval Ratio is as follows −
$$\mathrm{=\:\frac{\mathrm{Quick\: assets}}{\mathrm{Average\: Daily\: Expenses}}}$$
$$\mathrm{=\:\frac{\mathrm{Cash \:and\: Cash\: Equivalents\:+\:Marketable\: Securities\:+\: Accounts \:Receivables}}{\mathrm{Average\: Daily\: Expenses}}}$$
$$\mathrm{=\:\frac{\mathrm{\left ( Rs\: 50\: Crores + Rs\: 25\: Crores + Rs\: 25\: Crores \right )}}{\mathrm{Rs\: 2\: Crores}}}$$
$$\mathrm{=\:50\:\mathrm{Days}}$$
Key Features of Interval Ratio
Some of the key features of Interval ratio are as follows −
Measure the Strength of Company
Interval ratio is a powerful tool to measure the strength of a company to run on its own. It gives a true sense of the company’s survival without accessing the long-term debt and using only short-term assets. Usually, long-term debt is kept out of the calculation because it shows the long-term nature of the business. It does not show the competitive edge of a company.
Check the Survival Capacity of Company
The interval measure is a rough estimate to check the survival capacity of a company. It is quantitative in nature and does not include qualitative aspects.
For example, the interval ratio does not reveal the real reasons for a lesser measure or why the ratio is big for some given organizations. It just gives an idea of how long the resources will last if the expenses are carried on a given average spending basis.
Check Funding Availability
Investors and analysts are interested in calculating the interval measure because it gives an idea of the available funding of a company for a particular project. If the ratio is higher, it indicates that the company has enough funds which is a good indicator for the investors to invest in. If the ratio goes below a certain value, the company would need to resource more funding from external sources rather than relying on its own resources.
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