Does Sree Rayalaseema Hi-Strength Hypo's (NSE:SRHHYPOLTD) Statutory Profit Adequately Reflect Its Underlying Profit?

As a general rule, we think profitable companies are less risky than companies that lose money. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. This article will consider whether Sree Rayalaseema Hi-Strength Hypo's (NSE:SRHHYPOLTD) statutory profits are a good guide to its underlying earnings.

We like the fact that Sree Rayalaseema Hi-Strength Hypo made a profit of ₹187.5m on its revenue of ₹6.97b, in the last year. As you can see in the chart below, its profit has declined over the last three years, even though its revenue has increased.

See our latest analysis for Sree Rayalaseema Hi-Strength Hypo

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. So today we'll look at what Sree Rayalaseema Hi-Strength Hypo's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Sree Rayalaseema Hi-Strength Hypo.

A Closer Look At Sree Rayalaseema Hi-Strength Hypo's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Sree Rayalaseema Hi-Strength Hypo has an accrual ratio of -0.10 for the year to September 2019. That indicates that its free cash flow was a fair bit more than its statutory profit. Indeed, in the last twelve months it reported free cash flow of ₹516m, well over the ₹187.5m it reported in profit. Notably, Sree Rayalaseema Hi-Strength Hypo had negative free cash flow last year, so the ₹516m it produced this year was a welcome improvement.

Our Take On Sree Rayalaseema Hi-Strength Hypo's Profit Performance

As we discussed above, Sree Rayalaseema Hi-Strength Hypo has perfectly satisfactory free cash flow relative to profit. Because of this, we think Sree Rayalaseema Hi-Strength Hypo's earnings potential is at least as good as it seems, and maybe even better! Unfortunately, though, its earnings per share actually fell back over the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. Just as investors must consider earnings, it is also important to take into account the strength of a company's balance sheet. You can seeour latest analysis on Sree Rayalaseema Hi-Strength Hypo's balance sheet health here.

This note has only looked at a single factor that sheds light on the nature of Sree Rayalaseema Hi-Strength Hypo's profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.