The M-score was created by Professor Messod Beneish. Instead of measuring the bankruptcy risk (Z-score) or business trend (F-score), M -score can be used to detect the risk of earnings manipulation. This is the original research paper on M-score.
The M-Score Variables:
The M score is based on a combination of the following eight different indices:
DSRI = Days Sales in Receivables Index = (Receivablest/Salest/(Receivablest-1/Salest-1)
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= Gross_Margin_t-1/ Gross_Margin_t
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=(1-(CurrentAsset_t+PPE_t)/TotalAsset_t))/ (1-(CurrentAsset_t-1+PPE_t)/TotalAsset_t-1))
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=Sales_t/Sales_t-1
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=(Depreciation_t-1/(Depreciaton_t-1+PPE_t-1))/ =(Depreciation_t/(Depreciaton_t+PPE_t))
Measured as the ratio of the rate of depreciation in year t-1 to the corresponding rate in year t.
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=(SGA_t/Sales_t)/(SGA_t-1/Sales_t-1)
The ratio of SGA expenses in year t relative to year t -1.
SGA expenses index>1 means that the company is becoming less efficient in generate sales.
LVGI = Leverage Index=((LTD_t+CurrentLiabilities_t)/TotalAssets_t)/ =((LTD_t-1+CurrentLiabilities_t-1)/TotalAssets_t-1)
The ratio of total debt to total assets in year t relative to yeat t-1.
An LVGI >1 indicates an increase$sgai= in leverage
TATA - Total Accruals to Total Assets= (Income from Continuing Operationst - Cash Flows from Operationst) / Total Assetst
Total accruals calculated as the change in working capital accounts other than cash less depreciation.
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
An M-Score of less than -2.22 suggests that the company will not be a manipulator. An M-Score of greater than -2.22 signals that the company is likely to be a manipulator.