We Think That There Are Issues Underlying Zhejiang Songyuan Automotive Safety SystemsLtd's (SZSE:300893) Earnings

Zhejiang Songyuan Automotive Safety Systems Co.,Ltd. (SZSE:300893) announced strong profits, but the stock was stagnant. Our analysis suggests that shareholders have noticed something concerning in the numbers.

See our latest analysis for Zhejiang Songyuan Automotive Safety SystemsLtd

Examining Cashflow Against Zhejiang Songyuan Automotive Safety SystemsLtd's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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'.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to December 2023, Zhejiang Songyuan Automotive Safety SystemsLtd had an accrual ratio of 0.26. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥197.8m, a look at free cash flow indicates it actually burnt through CN¥128m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥128m, this year, indicates high risk.

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 Zhejiang Songyuan Automotive Safety SystemsLtd's Profit Performance

Zhejiang Songyuan Automotive Safety SystemsLtd didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Zhejiang Songyuan Automotive Safety SystemsLtd's statutory profits are better than its underlying earnings power. But the good news is that its EPS growth over the last three years has been very impressive. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. While conducting our analysis, we found that Zhejiang Songyuan Automotive Safety SystemsLtd has 1 warning sign and it would be unwise to ignore it.

Today we've zoomed in on a single data point to better understand the nature of Zhejiang Songyuan Automotive Safety SystemsLtd'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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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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.