Beneish M-Score

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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[edit]

The Beneish M-Score is calculated using 8 financial ratios.

Variables (financial ratios)[1][2][edit]

  • 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

Formula[edit]

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 [1]

How to interpret[edit]

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.

https://www.investopedia.com/terms/b/beneishmodel.asp

Important notices[edit]

  • 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).

Example of successful application[edit]

Enron Corporation was correctly identified as an earnings manipulator by students from Cornell University using M-Score. Noticeably, Wall Street financial analysts were still recommending to buy Enron shares at that point in time.

Further reading on financial statement manipulation[edit]

A sequence of articles on Alpha Architect blog.[3][4][5]

An article on Investopedia about different types of financial statement manipulation (Smoke and Mirrors, Elder Abuse, Fleeing Town and others).[6]

See also[edit]

References[edit]

  1. ^ a b "The Detection of Earnings Manipulation Messod D. Beneish". Scribd. Retrieved 2017-01-08.
  2. ^ "Beneish M Score Definition". ycharts.com. Retrieved 2017-01-08.
  3. ^ "Attention Value Investors: How to Predict Accounting Trickery". Alpha Architect. 2015-04-20. Retrieved 2017-01-28.
  4. ^ "The Accrual Anomaly For Dummies". Alpha Architect. 2011-09-07. Retrieved 2017-01-28.
  5. ^ "Managing the Risks of Permanent Capital Impairment (Part 1 of 4)". Alpha Architect. 2012-06-25. Retrieved 2017-01-28.
  6. ^ Beattie, Andrew (2006-11-26). "Common Clues Of Financial Statement Manipulation". Investopedia. Retrieved 2017-01-28.