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.

The Beneish M-score is calculated using 8 variables (financial ratios):^[1][2]

• Days Sales in Receivables Index

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

• Gross Margin Index (GMI)

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

• Asset Quality Index (AQI)

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)]

• Sales Growth Index (SGI)

SGI = Sales_t / Sales_t-1

• Depreciation Index (DEPI)

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

• Sales General and Administrative Expenses Index (SGAI)

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

• Leverage Index (LVGI)

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]

• Total Accruals to Total Assets (TATA)

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

The formula to calculate the M-score is:^[1]

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

The threshold value is -1.78 for the model whose coefficients are reported above. (see Beneish 1999, Beneish, Lee, and Nichols 2013, and Beneish and Vorst 2020).

• If M-score is less than -1.78, the company is unlikely to be a manipulator. For example, an M-score value of -2.50 suggests a low likelihood of manipulation.
• If M-score is greater than −1.78, the company is likely to be a manipulator. For example, an M-score value of -1.50 suggests a high likelihood of manipulation.

A 2023 research paper will use an aggregate score of many companies to predict recessions. It finds that the score in early 2023 is the highest in some 40 years.^[3][4]

• 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 since these institutions make money through different routes. Sales and receivables which are two main ingredients that go into the Beneish formula are not used when analyzing a financial institution.

Enron Corporation was correctly identified 1998 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..^[5][6]

• A sequence of articles on Alpha Architect blog.^[7][8][9]
• An article on Investopedia about different types of financial statement manipulation ("smoke and mirrors", "elder abuse", "fleeing town", and others).^[10]

• Data analysis techniques for fraud detection
• Benford's law
• Piotroski F-score
• Ohlson O-score
• Altman Z-score