Forensic accounting models evaluate reported financial statements to detect statistical anomalies in earnings quality, working capital movements, and balance sheet solvency.
Beneish M-Score (Earnings Manipulation)
Developed by Professor Messod Beneish, the M-Score is a probabilistic model designed to detect whether a company's financial results exhibit patterns historically associated with earnings manipulation.
The 5-factor Beneish model evaluates: - SGI (Sales Growth Index): Ratio of current-year sales to prior-year sales. - GMI (Gross Margin Index): Ratio of prior-year gross margin to current-year gross margin. A value above 1.0 signals deteriorating margins. - AQI (Asset Quality Index): Proportion of non-current assets other than tangible PP&E. Rising AQI indicates capitalisation of operating costs. - LVGI (Leverage Index): Ratio of total debt to total assets. - TATA (Total Accruals to Total Assets): Accruals calculated as $(\text{Net Income} - \text{Cash Flow from Operations}) / \text{Total Assets}$.
$$\text{M-Score} = -4.84 + 0.920 \times \text{DSRI} + 0.528 \times \text{GMI} + 0.404 \times \text{AQI} + 0.892 \times \text{SGI} + 0.115 \times \text{DEPI} - 0.172 \times \text{SGAI} + 4.037 \times \text{TATA} + 0.0327 \times \text{LVGI}$$
An M-Score greater than -1.78 suggests a higher statistical probability of accounting distortions.
Altman Z''-Score (Solvency & Distress)
Adapted for emerging markets and non-manufacturing firms, the Altman Z''-Score assesses balance sheet distress through four weighted financial ratios:
$$Z'' = 6.56 \times X_1 + 3.26 \times X_2 + 6.72 \times X_3 + 1.05 \times X_4$$
Where: - $X_1 = \text{Working Capital} / \text{Total Assets}$ - $X_2 = \text{Retained Earnings} / \text{Total Assets}$ - $X_3 = \text{EBIT} / \text{Total Assets}$ - $X_4 = \text{Book Value of Equity} / \text{Total Liabilities}$
Z''-Score zones: - Distress Zone: $Z'' < 1.10$ - Grey Zone: $1.10 \le Z'' \le 2.60$ - Safe Zone: $Z'' > 2.60$
Piotroski F-Score (Fundamental Health)
The Piotroski F-Score evaluates 9 discrete fundamental signals across profitability, leverage, and operating efficiency. Each passing metric adds 1 point, yielding a total score from 0 (weakest) to 9 (strongest).