Softchoice's (TSE:SFTC) Conservative Accounting Might Explain Soft Earnings

Shareholders appeared unconcerned with Softchoice Corporation's (TSE:SFTC) lackluster earnings report last week. Our analysis suggests that while the profits are soft, the foundations of the business are strong.

Check out our latest analysis for Softchoice

Zooming In On Softchoice's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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.

Softchoice has an accrual ratio of -0.46 for the year to September 2024. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of US$91m in the last year, which was a lot more than its statutory profit of US$39.2m. Softchoice's year-on-year free cash flow was as flat as two-day-old fizzy drink.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Softchoice's Profit Performance

As we discussed above, Softchoice's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Softchoice's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! On the other hand, its EPS actually shrunk in the last twelve months. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it's equally important to consider the risks facing Softchoice at this point in time. When we did our research, we found 3 warning signs for Softchoice (1 is concerning!) that we believe deserve your full attention.

Today we've zoomed in on a single data point to better understand the nature of Softchoice'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 with high insider ownership.

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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.