Beneish M Score
The Beneish M score was created by Professor Messod Beneish to detect earnings manipulation.
It is an extremely useful quality check when screening for attractive stock investments.
BENEISH M SCORE FORMULA
DSRI = Days Sales in Receivables Index
Measured as the ratio of days' sales in receivables in year t to year t-1. A large increase in DSR could be indicative of revenue inflation.
GMI = Gross Margin Index
Measured as the ratio of gross margin in year t-1 to gross margin in year 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 is measured as the ratio of non-current assets other than plant, property and equipment to total assets. AQI is the ratio of asset quality in year t to year t-1.
SGI = Sales Growth Index
Ratio of sales in year t to sales in year t-1. Sales growth is not itself a measure of manipulation. However, growth companies are likely to find themselves under pressure to manipulate in order to keep up appearances.
DEPI = Depreciation Index
Measured as the ratio of the rate of depreciation in year t-1 to the corresponding rate in year t. A DEPI greater than 1 indicates that assets are being depreciated at a slower rate. This suggests that the firm might be revising useful asset life assumptions upwards, or adopting a new method that is income friendly.
SGAI = Sales, General and Administrative expenses Index
The ratio of SGA expenses in year t relative to year t -1.
LVGI = Leverage Index
The ratio of total debt to total assets in year t relative to yeat t-1. An LVGI >1 indicates an increase in leverage.
TATA - Total Accruals to Total Assets
Total accruals calculated as the change in working capital accounts other than cash less depreciation."
Beneish M Score Formula (Original 8 Variables)
The eight variables are then weighted together according to the following:
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
A score greater than -1.78 indicates a strong likelihood of a firm being a manipulator. In his out of sample tests, Beneish found that he could correctly identify 76% of manipulators, whilst only incorrectly identifying 17.5% of non-manipulators.
Beneish M Score Formula (Revised 5 Variables)
The five variable version 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
A score greater than -1.78 indicates a strong likelihood of a firm being a manipulator.
