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The Beneish model is a statistical model that uses financial ratios calculated with accounting data of a specific company in order to check if it is likely (high probability) that the reported earnings of the company have been manipulated.
How to calculate
- Days Sales in Receivables Index
(DSRI) DSRI = (Net Receivablest / Salest) / (Net Receivablest-1 / Salest-1)
- Gross Margin Index (GMI)
GMI = [(Salest-1 - COGSt-1) / Salest-1] / [(Salest - COGSt) / Salest]
- Asset Quality Index (AQI)
AQI = [1 - (Current Assetst + PP&Et + Securitiest) / Total Assetst] / [1 - ((Current Assetst-1 + PP&Et-1 + Securitiest-1) / Total Assetst-1)]
- Sales Growth Index (SGI)
SGI = Salest / Salest-1
- Depreciation Index (DEPI)
DEPI = (Depreciationt-1/ (PP&Et-1 + Depreciationt-1)) / (Depreciationt / (PP&Et + Depreciationt))
- Sales General and Administrative Expenses Index (SGAI)
SGAI = (SG&A Expenset / Salest) / (SG&A Expenset-1 / Salest-1)
- Leverage Index (LVGI)
LVGI = [(Current Liabilitiest + Total Long Term Debtt) / Total Assetst] / [(Current Liabilitiest-1 + Total Long Term Debtt-1) / Total Assetst-1]
- Total Accruals to Total Assets (TATA)
TATA = (Income from Continuing Operationst - Cash Flows from Operationst) / Total Assetst
The formula to calculate the M-score is:
- M-score = −4.84 + 0.92 × DSRI + 0.528 × GMI + 0.404 × AQI + 0.892 × SGI + 0.115 × DEPI −0.172 × SGAI + 4.679 × TATA − 0.327 × LVGI
How to interpret
The threshold value is −2.22:
- If M-score is less than −2.22, the company is unlikely to be a manipulator.
- If M-score is greater than −2.22, the company is likely to be a manipulator.
- Beneish M-score is a probabilistic model, so it cannot detect companies that manipulate their earnings with 100% accuracy.
- Financial institutions were excluded from the sample in Beneish paper when calculating M-score. It means that the M-score for fraud detection cannot be applied among financial firms (banks, insurance).[dubious ]
Example of successful application
Enron Corporation was correctly identified[when?] as an earnings manipulator by students from Cornell University using M-score. Noticeably, Wall Street financial analysts[who?] were still recommending to buy Enron shares at that[which?] point in time.
Further reading on financial statement manipulation
- A sequence of articles on Alpha Architect blog.
- An article on Investopedia about different types of financial statement manipulation ("smoke and mirrors", "elder abuse", "fleeing town", and others).
- Messod D. Beneish. "The Detection of Earnings Manipulation". Scribd. Retrieved 2017-01-08.
- "Beneish M Score Definition". ycharts.com. Retrieved 2017-01-08.
- "Attention Value Investors: How to Predict Accounting Trickery". Alpha Architect. 2015-04-20. Retrieved 2017-01-28.
- "The Accrual Anomaly For Dummies". Alpha Architect. 2011-09-07. Retrieved 2017-01-28.
- "Managing the Risks of Permanent Capital Impairment (Part 1 of 4)". Alpha Architect. 2012-06-25. Retrieved 2017-01-28.
- Beattie, Andrew (2006-11-26). "Common Clues Of Financial Statement Manipulation". Investopedia. Retrieved 2017-01-28.