M Score

M Score

The Beneish M-Score is the result of the calculation of the Beneish model, which uses financial ratios to determine whether a company has manipulated its profits. It is a tool used to detect financial fraud. The model was created by professor Messod Beneish in June 1999 after publishing a paper called The Detection of Earnings Manipulation. 

M-Score calculates the degree of manipulation in earnings by the company. The Beneish M-Score model helps analysts in predicting these high-profile failures. 

The Beneish M-Score (M) is made up of eight variables which are as follows:

The formula for the Beneish M-score is: 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 

Variable 1-Days Sales in Receivables Index (DSRI)

It is the ratio of days sales in receivables in a year concerning 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)

Variable 2 - Gross Margin Index (GMI)

It is the ratio of the year’s gross margin concerning the previous year.

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

Variable 3 - Asset Quality Index (AQI)

The ratio of non-current assets

 (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)]

Variable 4 -  Sales Growth Index (SGI)

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

SGI = Salest / Salest-1

Variable 5 - Depreciation Index (DEPI)

The ratio of the depreciation rate of a year

 to the previous year.

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

Variable 6 - Sales, General, and Administrative expenses Index (SGAI)

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

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

Variable 7 - Leverage Index (LVGI)

It is the ratio of total debt to total assets of a year concerning 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]

Variable 8 -  Total Accruals to Total Assets (TATA)

It is calculated as the change in working capital

 accounts other than the cashless depreciation.

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