Looking back at the SPAC craze over time, we have seen a number of frauds going public. Some include Nikola Corp (Nasdaq: NKLA) and WeWork (NYSE: WE). There were also many companies that were eventually discovered as frauds, such as WireCard (FRA:WDI), CoAssets (ASX:CA8) and of course, the one and only Enron (NYSE: ENE). How do investors get an indication on the probability of getting into a scam?

In comes the Beneish M-Score. This is derived from a mathematical model that uses financial ratios and eight variables to identify whether a company has manipulated its earnings.

These variables are derived from the financial numbers that could easily be found in the company’s financial model. These variables are the Days Sales in Receivables Index (DSRI), Gross Margin Index (GMI), Asset Quality Index (AQI), Sales Growth Index (SGI), Depreciation Index (DEPI), Sales General and Administrative Expenses Index (SGAI), Leverage Index (LVGI) and Total Accruals to Total Assets (TATA).

See the formula sheet here.

If the score is less than -1.78, the likelihood of the company being a manipulator is low. However, if it is higher than -1.78, there is a higher probability that earnings could have been manipulated.

However, do note that the Beneish M-score is a probabilistic model. Therefore, it cannot detect companies that manipulate their earnings with 100% accuracy. Also, financial institutions such as banks and insurance companies were excluded from the sample in Beneish paper when calculating M-score. This means that the M-score for fraud detection cannot be applied among financial firms.

For those who are interested, you can find Beneish’s original 1999 paper here. Our team is has also created a new Beneish M-Score calculator for your own use. Catch you all soon!