Irwin Naturals (CSE:IWIN) Is Posting Promising Earnings But The Good News Doesn’t Stop There

The market seemed underwhelmed by the solid earnings posted by Irwin Naturals Inc. (CSE:IWIN) recently. Along with the solid headline numbers, we think that investors have some reasons for optimism.

Check out our latest analysis for Irwin Naturals

Zooming In On Irwin Naturals' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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.

For the year to September 2021, Irwin Naturals had an accrual ratio of -0.47. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of US$17m during the period, dwarfing its reported profit of US$7.37m. Irwin Naturals' free cash flow improved over the last year, which is generally good to see. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Irwin Naturals.

How Do Unusual Items Influence Profit?

Irwin Naturals' profit was reduced by unusual items worth US$2.4m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect Irwin Naturals to produce a higher profit next year, all else being equal.

Our Take On Irwin Naturals' Profit Performance

Considering both Irwin Naturals' accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. After considering all this, we reckon Irwin Naturals' statutory profit probably understates its earnings potential! If you want to do dive deeper into Irwin Naturals, you'd also look into what risks it is currently facing. To help with this, we've discovered 3 warning signs (1 doesn't sit too well with us!) that you ought to be aware of before buying any shares in Irwin Naturals.

Our examination of Irwin Naturals has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.