Business resilience is not just about profitability. A resilient business has sufficient cash resources to withstand unexpected disruptions, meet its obligations, and continue operating when conditions become challenging.
Three key measures that every business owner should understand are:
- Defensive Interval Ratio
- Cash Runway (Business Burn Rate)
- Lockup (WIP + Debtors)
Together, these measurements provide valuable insight into a business's liquidity, cash flow, and ability to survive adverse circumstances.
1. Defensive Interval Ratio (DIR)
The Defensive Interval Ratio is an excellent indicator of business resilience.
It measures how long a business can continue paying its bills without generating additional sales and is often used alongside the Quick Ratio to assess short-term financial risk.
Formula
(Cash + Cash Equivalents + Trade Receivables) / Average Daily Expenses
Example
Assume your business has:
- $25,000 in the bank
- $60,000 owed by customers
- Average daily expenses of $2,000
Calculation:
($25,000 + $60,000) / $2,000
= $85,000 ÷ $2,000
Defensive Interval Ratio = 42.5 days
This means the business could continue paying its average daily expenses for approximately 42 days without generating additional sales.
The higher your Defensive Interval Ratio:
- The more resilient your business is.
- The better positioned you are to manage unexpected disruptions.
- The less dependent you are on immediate sales or external funding.
A low Defensive Interval Ratio may indicate that a business is vulnerable to cash flow pressures, economic downturns, or unexpected events.
2. Cash Runway (Business Burn Rate)
The Cash Runway is also commonly referred to as the Business Burn Rate.
It is a critical Key Performance Indicator (KPI), particularly for:
- Start-up businesses
- High-growth businesses
- Businesses operating at a temporary loss
- Companies seeking investment or funding
What Is Burn Rate?
Burn Rate measures how much cash a business is losing over a given period, usually monthly.
For example:
Business Burn Rate = $45,000 per month
This means the business is consuming $45,000 of cash each month.
What Is Cash Runway?
Cash Runway measures how long the business can continue operating before it exhausts its available cash resources.
It provides an indication of how long a company has before it must:
- Become profitable;
- Raise additional capital;
- Secure new funding; or
- Significantly reduce expenses.
Factors Affecting Cash Runway - Your Cash Runway is largely determined by:
- Cash at bank;
- Available overdraft facilities;
- Available borrowings; and
- Accounts Receivable.
It is important to recognise that Accounts Receivable are not cash. They are simply amounts owed by customers that are expected to become cash once collected.
The faster debtors are collected, the longer the effective cash runway of the business.
Businesses rarely fail because they run out of profit. They fail because they run out of cash.
Monitoring your Cash Runway allows management to identify potential financial pressure well before a crisis develops.
3. Lockup (WIP + Debtors)
Lockup measures the amount of time it takes to convert work completed into cash received.
It is calculated as:
Lockup Days = WIP Days + Debtor Days
Components of Lockup
Debtors (Accounts Receivable) represent money owed to the business by customers.
The objective is to convert invoices into cash as quickly as possible.
Businesses can improve their debtor performance by:
- Having clear terms of trade.
- Making payment easy for customers.
- Issuing statements promptly on overdue accounts.
- Following up overdue balances regularly.
- Sending reminder letters.
- Calling customers regarding outstanding debts.
The faster customers pay, the stronger the cash flow position of the business.
Work In Progress (WIP)
WIP represents work that has been completed but has not yet been invoiced. For many professional service businesses, excessive WIP can be a significant drain on cash flow.
Until an invoice is issued, completed work cannot be collected and converted into cash.
Businesses can reduce WIP by:
- Clearly communicating project requirements to clients.
- Obtaining information from clients promptly.
- Issuing interim or progress invoices.
- Reviewing WIP regularly.
- Issuing invoices immediately upon completion of work.
The quicker work is invoiced, the quicker it can be collected.
Why Lockup Matters - Many profitable businesses experience cash flow challenges because too much money is tied up in:
- Unbilled work (WIP); and
- Outstanding customer invoices (Debtors).
A reduction in Lockup can release significant cash into the business without increasing sales or profitability.
Reducing Lockup:
- Improves cash flow;
- Reduces reliance on debt;
- Strengthens liquidity;
- Extends Cash Runway; and
- Improves overall business resilience.
These three metrics are closely connected:
Lower Lockup
↓
More Cash Available
↓
Higher Defensive Interval Ratio
↓
Longer Cash Runway
↓
Greater Business Resilience
Conversely:
Higher Lockup
↓
Less Cash Available
↓
Lower Defensive Interval Ratio
↓
Shorter Cash Runway
↓
Greater Financial Risk
Every business owner should be able to answer:
- How many days can we survive without additional sales?
- How many months before our cash resources are exhausted?
- How long does it take to convert work into cash?
- How much cash is trapped in WIP?
- How much cash is trapped in debtors?
- What actions can we take this month to improve liquidity?
Business resilience is fundamentally about cash flow management. A business with strong profits but poor cash flow can still fail. Conversely, a business with disciplined cash management can often survive difficult trading conditions and emerge stronger.
By regularly monitoring:
- Defensive Interval Ratio
- Cash Runway
- WIP Days
- Debtor Days
- Lockup
Business owners can identify risks early, improve liquidity, and significantly strengthen the resilience of their business.
If you would like to discuss further please contact us:
McNamara & Company - Chartered Accountants, located minutes from the Melbourne CBD
www.mcnamaraandco.au/contact-us
Phone +61 3 9428 1062
Email admin@mcnamaraandco.au
Please refer to disclaimer at the bottom of the page.
