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.
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.
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.
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.
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