Beneish M-Score: Calculations and Result Interpretations

WHERE:

• t is the first year in which manipulation has been uncovered and t-1 is the previous year.

DSRI Result interpretation:

A significant increase (DSRI > 1) in the ratio may indicate:

• Тhe likelihood of overestimating earnings through accelerated recognition of revenue.
• Тhe change in credit policy to boost sales by providing additional deferred payment.

WHERE:

• COGS - Cost of Goods Sold
• GMI (Gross Margin Index) is the ratio of Gross Margin in year t-1 to Gross Margin in year t.
• Gross Profit = Revenue (Sales) – Cost of Goods Sold (COGS)

GMI Result interpretation:

GMI > 1:

• Gross Margin has deteriorated;
• Negative sign about a firm’s prospects;
• High probability of earnings manipulations and misleading financial reports creation.

WHERE:

• CA - Current Assets
• TA - Total Assets
• PPE - Property, Plant and Equipment
• AQI is the ratio of non-current assets other than property, plant and equipment (PPE) to total assets. This indicator helps to disclose the manipulations in the assets of a company. AQI is the ratio of asset quality in year t relative to corresponding measure in year t-1.

AQI Result interpretation:

AQI > 1:

• Company has increased its cost deferral (improper, illegal, excessive capitalization of expenses) or increased its intangible assets;
• Sign of potential earnings manipulations;
• The higher the ratio, the greater the probability of profit manipulation.

WHERE:

• Ratio of Revenue (Sales) in year t to Revenue (Sales) in previous year t-1.

SGI Result interpretation:

SGI > 1:

• Sales growth in year t compared to the prior year t-1.
• High sales growth itself does not mean of earnings manipulation, however, high growth companies are more likely to commit financial fraud in order to keep up the appearance of high sales.

WHERE:

• Depr - Depreciation
• PPE - Property, Plant and Equipment
• Measured as the ratio of the rate of depreciation in year t-1 versus year t.

DEPI Result interpretation:

DEPI > 1:

• Signal of a potential manipulation.
• Assets are being depreciated at a slower rate.

Income increases due to adjusting depreciation methods; i.e., the company revises upwards the estimates of assets useful lives. In such a way, company may increase income by cutting expenses.

WHERE:

• SGA - Selling, general and administrative costs
• Measures the change in the Selling, general and administrative costs (SGA) as a percentage of sales of the year t compared with the prior year t-1.

SGAI Result interpretation:

SGAI > 1:

• There is a probability of manipulation and financial statement fraud.
• Sales and administrative expenses increased proportionally more than sales. The increase in expenditures compared to sales is interpreted as a negative sign concerning the company’s future prospects: management is not successful in controlling expenses; decrease in administrative and marketing efficiency.
• The company is becoming less efficient in generate sales.

WHERE:

• LTD - Long Term Debt
• CL - Current Liabilities
• TA - Total Assets
• It is the ratio of a company’s total debt to total assets in year t relative to the corresponding ratio of previous year t-1.

LVGI Result interpretation:

LVGI > 1:

• High risk of financial statement manipulation.
• Indicates an increase in financial leverage.
• Growth in the interest expenses as a result of an increase in financial leverage, which is reflected in the company's net profit.
• Incentive for earnings manipulations in order to meet debt covenants.
• There is a higher probability that a company will breach a debt covenant.

Methods of calculation:

WHERE:

• Working Capital = Current assets - Current liabilities
• Depr - Depreciation
• ICO - Income from Continuing Operations
• CFO - Cash Flows from Operations
• TATA index is the ratio of total accruals relative to total assets, where total accruals are calculated as the change in working capital accounts (other than cash) less depreciation.

TATA Result interpretation:

Increasing accruals as part of total assets:

• High chance of manipulation.
• Accruals could be used to manipulate earnings.
• The greater the level of accruals (less cash), the higher the likelihood of profit manipulation.
• Indicates a company's possible accounting aggressiveness policies, which have a more positive impact on reported profits.

• More information about: “Cash Basis and Accrual Basis Accounting Methods”