Detecting Potential Financial Manipulation

In fundamental analysis, besides looking for the potential earnings growth of a company, one has to ensure that the company’s financial position is healthy.  However, analysing a company’s financial statement is not an easy task; one has to go through many annual reports, read the notes and understand the details of each entry in the financial statement.  Often, the process is time consuming.

In 1999, Dr. Messod Beneish, an accounting professor at Indiana University’s Kelly School of Business published a research paper called “The Detection of Earning Manipulation”.     He introduced a simple analysis method, the Beneish M Score, to detect potential financial manipulation by using information that is readily available in the financial statement.

The Beneish M Score is calculated using eight financial ratios with different weightage.

M-Score= -4.840 + 0.920DSRI + 0.528GMI + 0.404AQI + 0.892SGI + 0.115 DEPI - 0.172SGAI + 4.697TATA - 0.327LVGI

where,

       DSRI            =          Days Sales Receivables Index

       GMI             =          Gross Margin Index

       AQI              =          Asset Quality Index

       SGI              =          Sales Growth Index

       DEPI            =          Depreciation Index

       SGAI            =          Sales, General, Administrative Expenses Index

       TATA           =          Total Accruals to Total Assets

       LVGI            =          Leverage Index

For M-Score that is smaller than -1.78 (more negative) is classified as non-manipulator.  Whereas for M-Score that is larger than -1.78 (moving towards zero or positive) is classified as a possible manipulation.

The table below, shows the M-Score for various companies in Malaysia.

Company	Beneish M-Score
	2016	2015	Benchmark
PETRONAS	-2.713	-2.791	Normal < -1.78 < Cautious
TNB	-2.814	-2.587	Normal < -1.78 < Cautious
SIME DARBY	-2.649	-2.364	Normal < -1.78 < Cautious
FGV	-2.624	-1.778	Normal < -1.78 < Cautious

All the companies in the table showed to be normal under the M-Score test except for FGV in 2015.  But in 2016, FGV reverted to normal.  Perhaps, a more detailed analysis of FGV’s financial statement may be required.

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