The Earnings Manipulation Risk Indicator gives a visual representation of how likely it is that a company's management has been manipulating the accounts to inflate earnings. The indicator is based on the Beneish M-Score, a statistical measure derived from a set of 8 ratios drawn from a company's accounts. If the switch is on, Beneish's research implies a ~86% probability that the firm is manipulating earnings
Vodafone has an M-Score of -2.84.
As the score is below -1.78, this indicates that the company is unlikely to be manipulating earnings.
The Beneish M-score is a classification model based on combining multiple ratios. However, the following tests give an indication for the key factors driving the M-score which can be used a starting point for further investigation.
Note: Beneish's original research was sector-agnostic (apart from excluding financial companies). However, because it relies on ratios like gross margin, it may be unavailable (or less meaningful) for sectors with atypical financial profiles, e.g. oil E&P companies.
Note also: The exact Beneish threshold varies depending on the relative error costs of missing out potential manipulators versus mis-classifying a non-manipulator (Type 1 vs. Type II). A -1.78 threshold implies a 13.8% chance of mis-classifying a non-manipulator, which Beneish suggests is a reasonable compromise level.
Are receivables increasing in proportion to sales?
A disproportionate increase in receivables may suggest the company is inflating sales figures by booking sales earlier or by extending better credit terms to customers and so on. The average for non-manipulators found in the Beneish study was 1.031 as compared with 1.465 for manipulators. Testing:Days Sales in Receivables Index < 1.248
Days Sales in Receivables Index = 1.08
This compares profit from the previous period with the current period. Gross margin deterioration can be a signal that a company is losing pricing power. Companies with poorer prospects have been shown to be more likely to engage in earnings manipulation. The average for non-manipulators in the study was 1.014 as compared with 1.193 for manipulators. Testing:Gross Margin Index < 1.1035
Asset quality is calculated by comparing current period with previous period for non-current assets less property, plant and equipment, divided by total assets. This measures the proportion of total assets for which future benefits are less certain. It is a possible sign of improper capitalization of expenses and cost deferral. The average for non-manipulators in the study was 1.039 as compared with 1.254 for manipulators. Testing:Asset Quality Index < 1.1465
This compares current period sales with the previous period. While sales growth does not imply manipulation on its own, growth firms are more likely to manipulate because their financial position and capital needs put pressure on managers to achieve earnings targets. The average for non-manipulators in the study was 1.134 as compared with 1.607 for manipulators. Testing:Sales Growth Index < 1.3705
A decreasing depreciation rate may indicate that the firm has revised upwards the estimates of assets' useful lives or adopted a new depreciation method that is income increasing. The average for non-manipulators in the study was 1.001 as compared with 1.077 for manipulators. Testing:Depreciation Index < 1.039
Depreciation Index = 1.10
Are sales, general and administrative expenses under control?
A disproportionate increase in SGA is viewed by analysts as a negative signal about a firm's future prospects. The average for non-manipulators in the study was 1.054 as compared with 1.041 for manipulators. Testing:SGA Expenses Index > 1.0475
If leverage is increasing, there is a pressure on management not to breach debt covenants. This may act as an incentive for earnings manipulation. The average for non-manipulators in the study was 1.037 as compared with 1.111 for manipulators. Testing:Leverage Index < 1.074
Excessive accruals may mean that managers are making discretionary accounting choices to alter earnings. This is calculated by raking the sum of the change in working capital, less the change in cash, less the change in current taxes payable, less depreciation and amortization, divided by total assets. The average for non-manipulators in the study was 0.018 as compared with 0.031 for manipulators. Testing:Accruals to Assets Index < 0.0245
Accruals to Assets Index = -0.072
For further information on how the M-Score is calculated click here.
To view all the stocks with the worst M-Score record click here.