Beneish M-Score

Beneish M-Score Definition

Beneish M score is the mathematical model which was created by Professor Messod Beneish and it is used for the purpose of finding out that whether the company has done any sort of manipulation with its earning with the help of the different financial ratios and the eight mentioned different variables.

The eight variables required for calculating the M-Score are calculated using the data from the income statement, balance sheet, and cash flows of the company, and then M-Score is calculated to know the degree of manipulation in earnings by the company.

  • If Beneish M-score is less than the -2.22, then it suggests that the company under consideration is not a manipulator.
  •  If Beneish M-score is more than -2.22, then it provides the signal that the company can be the manipulator.

Components of Beneish M-Score

The Beneish M score is calculated on the basis of the combination of eight different types of indices, which are as follows:

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For eg:
Source: Beneish M-Score (wallstreetmojo.com)

#1. Days’ Sales in Receivables Index (DSRI)

It is the ratio of days sales in receivables in a year with respect to the previous year. The large increase in the value of DSR is an indicator of revenue inflation.

DSRI = (Net Receivablest / Salest) / Net Receivables t-1 / Sales t-1)

#2. Gross Margin Index (GMI)

It is the ratio of gross margin of a year with respect to the previous year.

GMI = [(Sales t-1– COGS t-1) / Sales t-1] / [(Salest – COGSt) / Salest]

#3. Asset Quality Index (AQI)

It is the ratio of non-current assetsNon-current AssetsNon-current assets are long-term assets bought to use in the business, and their benefits are likely to accrue for many years. These Assets reveal information about the company's investing activities and can be tangible or intangible. Examples include property, plant, equipment, land & building, bonds and stocks, patents, trademark.read more (other than the plant, property and the equipment) to total assets of a year versus the prior year.

AQI = [1 – (Current Assetst + PP&Et + Securitiest) / Total Assetst] / [1 – ((Current Assets t-1+ PP&E t-1 + Securities t-1) / Total Assets t-1)]

#4. Sales Growth Index (SGI)

It is the ratio of sales of a year with respect to the previous year.

SGI = Salest / Salest-1

#5. Depreciation Index (DEPI)

It is the ratio of the rate of depreciation of a yearRate Of Depreciation Of A YearThe depreciation rate is the percent rate at which an asset depreciates during its estimated useful life. It can also be defined as the percentage of a company's long-term investment in an asset that the firm claims as a tax-deductible expense throughout the asset's useful life.read more with respect to the previous year.

DEPI = (Depreciation t-1/ (PP&E t-1 + Depreciation t-1)) / (Depreciation t / (PP&E t + Depreciation t))

#6. Sales, General, and Administrative expenses Index (SGAI)

It is the ratio of SG&A expenses of a year with respect to the previous year.

SGAI = (SG&A Expense t / Sales t) / (SG&A Expense t-1/ Sales t-1)

#7. Leverage Index (LVGI)

It is the ratio of total debt to total assets of a year with respect to the previous year.

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]

#8. Total Accruals to Total Assets (TATA)

It is calculated as the change in the accounts of working capitalWorking CapitalWorking capital is the amount available to a company for day-to-day expenses. It's a measure of a company's liquidity, efficiency, and financial health, and it's calculated using a simple formula: "current assets (accounts receivables, cash, inventories of unfinished goods and raw materials) MINUS current liabilities (accounts payable, debt due in one year)"read more other than the cashless depreciation

TATA = (Income from the Continuing Operations t – Cash Flows from the Operations t) / Total Assets t

Beneish M Score Formula

Eight different types of indices are weighted together as per the following formula to derive at the M-score:

Beneish M Score Formula = -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

Calculation of Beneish M-Score (with Examples)

The following are the different Beneish ratios. Calculate the M-score.

You can download this Beneish M-Scroe Excel Template here – Beneish M-Scroe Excel Template

  1. DSRI : 0.814
  2. GMI : 1.556
  3. AQI : 0.608
  4. SGI : 0.755
  5. DEPI : 0.801
  6. SGAI : 1.110
  7. LVGI : 0.878
  8. TATA : 0.044

Calculation of M-Score

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

Beneish M-Score Example 1

The M-score= -4.84 + 0.749 + 0.822 + 0.246 + 0.673 + 0.092 – 0.191 + 0.206 – 0.287

Beneish M-Score Example 1-1

M-score= -2.530

In this case, since the M-score is -2.53, which is less than -2.22, it implies that the company is not a manipulator.

Advantages of the Beneish M-Score

  1. It is helpful in knowing that up-to what extent the management of the company are manipulating its earnings as it calculates the degree of manipulation in earnings by the company
  2. It helps the analysts in detecting the financial accounting frauds in the company.

Disadvantages of the Beneish M-Score

  1. It is the probabilistic model that only gives the user the probability of manipulation and cannot detect the companies that manipulate financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more.
  2. The model does not apply to the financial firms as Professor Messod Beneish at the time of estimating the model did not include these firms.
  3. In case the management of the company has an idea about the calculation of the Beneish M-score model, then they would manipulate the balance sheet entries, which are considered for the calculation of M-Score. So, the purpose of M- score in that case will remain unfulfilled.

Important Points

  1. M-Score has two versions, i.e., 8 variable models and 5 variable models. The most widely used out of two versions is 8 variable Beneish’s models.
  2. Being the probabilistic model, the manipulation cannot be detected with the 100 5 accuracies.

Conclusion

M-Score is calculated to know the degree of manipulation in earnings by the company. Many of the companies can use different means of increasing their reported earnings like capitalization of the expenses, which are of revenue nature, early booking of the sales in the books of accounts, etc. These tricks, although they are not illegal by the law the same signifies the wrong working of the company. The Beneish M-Score model helps analysts in predicting these high profile failures.

Recommended Articles

This article has been a guide to what is Beneish M-Score and its definition. Here we will provide you the formula of Beneish M-Score and the basis for the combination of eight different indices to calculate the Beneish M score along with some practical examples. We also discuss the advantages and disadvantages. You can learn more about accounting from the following articles –

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