Beneish M-Score is a mathematical model that uses financial ratios and eight variables to identify whether a company has manipulated its earnings.
It was created by Professor Messod Beneish. In many ways it is similar to the Altman Z score, but optimized to detect earnings manipulation rather than bankruptcy.
It is based on a combination of the following eight different indices:
- DSRI = Days’ Sales in Receivables Index
- DSR = Receivable /Sale
- DSR t / DSR t-1
- A large increase in DSR could be indicative of revenue inflation.
- GMI = Gross Margin Index
- Gross Margin = (Sales - COGS)/Sales
- Gross Margin t-1/ Gross Margin t
- Gross margin has deteriorated when this index is above 1.
- A firm with poorer prospects is more likely to manipulate earnings.
- AQI = Asset Quality Index
- Asset Quality = Non Current Asset other than PPE / Total Asset
- AQI = AQI t / AQI t-1
- Note: Biological assets is part of PPE for a plantation company. Likewise for land held for development, property development costs, investment property for property companies.
- SGI = Sales Growth Index
- Sales t / Sales t-1
- Sales growth itself is not a measure of manipulation.
- A growth companies are likely to find themsleves under pressure to manipulate in order to keep up appearances
- DEPI = Depreciation Index
- Rate of Deprecition = Depreciation / (PPE + Depreciation)
- Rate of Deprecition t-1/ rate of Depreciation t
- > 1 indicates that assets are being depreciated at a slower rate - the firm might be
- revising useful asset life assumptions upwards
- adopting a new method that is income friendly.
- SGAI = Sales, General and Administrative expenses Index
- SGA = SGA Expenses / Sales
- SGA t / SGA t-1
- LVGI = Leverage Index
- Legerage = Total Debt / Total Asset
- Leverage t / Leverage t-1
- > 1 = increase in leverage
- TATA - Total Accruals to Total Assets
- Total Accruals = Change in Working Capital Account
M = -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
The interpretation...
- M Score > -1.78 - a strong likelihood of a firm being a manipulator.
Beneish found that he could correctly identify 76%
of manipulators, whilst only incorrectly identifying 17.5% of non-manipulators.
- It excludes SGAI, DEPI and LEVI which were not significant in the original Beneish model.
- M = -6.065 + 0.823*DSRI + 0.906*GMI + 0.593*AQI + 0.717*SGI + 0.107*DEPI
References:-
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