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.

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

(DSRI) DSRI = (Net Receivables_t / Sales_t) / Net Receivables_t-1 / Sales_t-1)

GMI = [(Sales_t-1 - COGS_t-1) / Sales_t-1] / [(Sales_t - COGS_t) / Sales_t]

AQI = [1 - (Current Assets_t + PP&E_t + Securities_t) / Total Assets_t] / [1 - ((Current Assets_t-1 + PP&E_t-1 + Securities_t-1) / Total Assets_t-1)]

SGI = Sales_t / Sales_t-1

DEPI = (Depreciation_t-1/ (PP&E_t-1 + Depreciation_t-1)) / (Depreciation_t / (PP&E_t + Depreciation_t))

SGAI = (SG&A Expense_t / Sales_t) / (SG&A Expense_t-1 / Sales_t-1)

LVGI = [(Current Liabilities_t + Total Long Term Debt_t) / Total Assets_t] / [(Current Liabilities_t-1 + Total Long Term Debt_t-1) / Total Assets_t-1]

TATA = (Income from Continuing Operations_t - Cash Flows from Operations_t) / Total Assets_t

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

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.

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.

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).

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