Beneish's Manipulation Index
CASE 5.4
Part B – Signals of Manipulation
Reviewing Beneish’s manipulation index, we note a high probability of manipulation for both fiscal Year 5 and Year 6. The major factors of this are the rapid growth in sales and the level of accruals in earnings. The Company experienced negative cash flows from operations for both years as a result in significant decreases in A/R and inventories. Reviewing the financial ratios, we also noted the relationship between inventories and COGS, which is not included in Beneish’s index. The high growth rate of sales should indicate the importance of the inventory turnover. By using average inventories as the denominator of the inventory turnover ratio for a firm with high growth rates will tend to increase the turnover rate. However, the inventory turnover ratios for the Company seem unusually small. The Company builds products to customer specifications and is in a field of high paced technological change. A turnover of inventory once every 200-300 days is a bit slower than would be expected. By including items in the ending inventory that should have been in COGS, the numerator decreased and the denominator increase for the ratio calculation, leading to a decreased turnover ratio.
Reviewing the financial statements of the Company, everything except for the inventory turnover ratio is reflective of what one might reasonable expect from a high-growth technology-based company.
Part F – Avoid bankruptcy? Problems with Altman model?
The Altman Z-score indicates a high probability of bankruptcy as of March 31,Year 7. This is mainly due to the current and past poor profitability. We noted, in previous years accounting irregularities caused some Z Scores to be overstated. In others, the high value of the common stock overshadowed everything else. As such, we see one of the problems with Altman’s model. It is based on whether one should invest in a company based on current market values. That’s where there is a
Part B – Signals of Manipulation
Reviewing Beneish’s manipulation index, we note a high probability of manipulation for both fiscal Year 5 and Year 6. The major factors of this are the rapid growth in sales and the level of accruals in earnings. The Company experienced negative cash flows from operations for both years as a result in significant decreases in A/R and inventories. Reviewing the financial ratios, we also noted the relationship between inventories and COGS, which is not included in Beneish’s index. The high growth rate of sales should indicate the importance of the inventory turnover. By using average inventories as the denominator of the inventory turnover ratio for a firm with high growth rates will tend to increase the turnover rate. However, the inventory turnover ratios for the Company seem unusually small. The Company builds products to customer specifications and is in a field of high paced technological change. A turnover of inventory once every 200-300 days is a bit slower than would be expected. By including items in the ending inventory that should have been in COGS, the numerator decreased and the denominator increase for the ratio calculation, leading to a decreased turnover ratio.
Reviewing the financial statements of the Company, everything except for the inventory turnover ratio is reflective of what one might reasonable expect from a high-growth technology-based company.
Part F – Avoid bankruptcy? Problems with Altman model?
The Altman Z-score indicates a high probability of bankruptcy as of March 31,Year 7. This is mainly due to the current and past poor profitability. We noted, in previous years accounting irregularities caused some Z Scores to be overstated. In others, the high value of the common stock overshadowed everything else. As such, we see one of the problems with Altman’s model. It is based on whether one should invest in a company based on current market values. That’s where there is a