In last couple of days there have been a lot of talk about a new instrument which can identify the red flags in the financial statements. This new instrument is called J-Score.
The J-score is a useful instrument in financial statement examination and is the part of Financial Forensic Rating Model designed by the leading international forensic accounting expert Mayur Joshi.
While deriving this score all the major American Studies were reviewed. This score is a classic example of how the American Empirical studies can be incorporated elsewhere.
The cash flows are extensively emphasized in this piece. Its primary goal is to discover creative accounting techniques.
J-Score is a measure of probable financial statement irregularities. This score is determined from the numerous financial statement aspects of Global corporations.
To generate the score, the forensic grading model based on the J-score takes into account information available from the annual reports available in the public domain.
The higher the score, the greater the likelihood of the firm engaging in creative accounting and eventually committing the financial statement fraud.
J-Score Parameters
The J-score is determined by 12 critical parameters in the financial accounts. They have various weights assigned to them. Cash flows from operations, revenue from operations, net profit from operations, fixed assets, reserves and surpluses, and long-term borrowings, contingent liabilities, shareholding of the promoters etc.
In forensic accounting, the J-score is one of the tools for identification of manipulative accounting practices. Though this is not the evidence of the accounting fraud and the evidences have to be collected by the forensic expert, this score acts as the guidance.
It aids in the evaluation of the business by investors. It may also have an impact on the investment decisions of investors.
Cashflow is most significant in J-score
J-Score emphasizes the Follow-the-Cash philosophy.
It places the greatest emphasis on the company's cash flow position. The J-score is based on the assumption that cash flow situations are difficult to manipulate and give the most weightage to cash flows. The J-Score is therefore based on the notion that negative cash flow indicates rising stress. This puts pressure on listed company management to use inventive accounting practices. It provides a more realistic view of the company's financials since it focuses more on cash flow.
Promoters Background
Though it is difficult to provide a quantitative value to the background of an Individual, this score makes it possible to evaluate every individual on 27 different risk parameters. This score have weightage of 40% in this score because the promoters/management are in the position to influence the decision of manipulating the accounting practices.
J-score is a technique that aids in determining where the firm is going wrong. It's a good way to look at every financial component of the business. The J-Score model may be applied to any financial statement data.
In current times, the J-Score report has become the most trustworthy report since it reflects the company's true and genuine position.
Conclusion
After applying the mathematical equation which is a complex calculation, the average J-score for publicly listed Indian corporations is found to be 0.59.
A score greater than 1 is considered bad. This model needs to evolve and will take its time. But for the global stock market investors, understanding this tool is going to be crucial.