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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

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 = /

  • Asset Quality Index (AQI)

AQI = /

  • 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 = /

  • 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 + 0.4.404 × 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 application of the M-Score for fraud detection among financial firms can potentially lead to wrong conclusions.

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 of time.

See also

References

  1. ^ "The Detection of Earnings Manipulation Messod D. Beneish". Scribd. Retrieved 2017-01-08.
  2. "Beneish M Score Definition". ycharts.com. Retrieved 2017-01-08.
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