# Beneish M-Score

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

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

### Variables (financial ratios)

• 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

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

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.

## Important notices

• 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

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

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).