The Beneish model is a mathematical model based on eight variables, which in turn are calculated from ratios. This model aims to estimate the probability that a company is misrepresenting its financial statements.
In other words, the Beneish model is a formula, made up of financial indicators, that allows determining if there is a probability that a company is manipulating or making up its accounting information.
This model is probabilistic, that is, it does not estimate the value of a variable or its projection, but instead casts a probability on an issue. In this case, the question would be: Could the company be presenting accounting information that is not reliable?
Now, at this point, you may be wondering why would a firm present false information? It may be, for example, that the estimated useful life of certain assets is being increased. In this way, depreciation expenses are decreased and, consequently, profits are artificially increased.
Origin of the Beneish model
Professor Messod Daniel Beneish of the Kelley School of Business, Indiana University, presented in a 1999 article the model that we explain in this article.
Beneish’s model is known because, as a curiosity, a group of Cornell University students, after applying it, warned about the manipulation of information within the Enron company. Said fraud would later be discovered and considered one of the five largest corporate scandals in history.
Beneish Model Formula
The Beneish model formula is as follows:
Now, let’s break down each part of the formula:
DSRI (by the acronym of its name in English Days Sales Receivables Index) = (accounts receivable from customers of the current year ÷ current year sales) ÷ (accounts receivable from customers from the previous year ÷ Sales of the previous year)
AQI (for the acronym of the name Asset Quality Index) = (Non-current assets of the current year ÷ Current Year Total Assets) ÷ (Non-current assets from last year ÷ Total assets last year)
In this ratio, it should be noted, plant, property and equipment are excluded from non-current assets.
DEPI (by the acronym of the name Depreciation Index) = [(Depreciación del año pasado ÷ (Depreciación+Planta, propiedad y equipo del año pasado)] ÷ [(Depreciación del año actual ÷ (Depreciación+Planta, propiedad y equipo del año actual)]
ACCRUALS (In other versions called TATA which is the acronym for Total Accruals to Total Assets) = (Profit before extraordinary items and discontinued operations* – operating cash flow) ÷ Total active
All the indicators shown so far are considered as signs of manipulation, that is, signs that the company may be falsifying information if the result of the ratio is greater than 1. So, if when calculating, for example, the ACCRUALS ratio, I obtain 1 .1, this increases the probability that beads are being made up.
Next, we will see what are known as motivation signals. These are those indicators that indicate that there is an incentive for the company’s management to manipulate the accounting information.
GMI (The acronym for Gross Margin Index) = (Gross Margin last year ÷ Gross Margin of the current year)
SGI (The acronym for Sales Growth Index) = Current year sales ÷ last year sales
SGAI (The acronym for Sales, general and administrative expenses) = (Selling, general and administrative costs of the current year ÷ current year sales) ÷ (Selling, general and administrative costs from last year ÷ last year’s sales)
LEVI (The acronym for Leverage Index) = [(Deudas a largo plazo+Pasivo corriente del año actual) ÷ Activos totales del año actual] ÷ [(Deudas a largo plazo+Pasivo corriente del año pasado) ÷ Activos totales del año pasado]
Interpretation of the result
Taking into account the formula presented, if the result is greater than -1.78, there is a probability of makeup of accounts that is greater than acceptable.
A result of -1.78 for a z score, in a normal distribution table, gives us a probability of 0.03754 (What is calculated in this model is a z score).
*Profit Before Extraordinary Items is that which deducts the payment of taxes. However, it does not take into account the profit or loss from extraordinary items. This item includes irregular events, such as a natural disaster, or operations corresponding to discontinued business units, that is, that have been abandoned or sold.