Zhejiang FORE Intelligent TechnologyLtd's (SZSE:301368) Problems Go Beyond Weak Profit

The market shrugged off Zhejiang FORE Intelligent Technology Co.,Ltd's (SZSE:301368) weak earnings report last week. Our analysis suggests that there are some positive factors lying below the troubling profit numbers which investors are finding comfort in.

Check out our latest analysis for Zhejiang FORE Intelligent TechnologyLtd

A Closer Look At Zhejiang FORE Intelligent TechnologyLtd'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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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 having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to March 2024, Zhejiang FORE Intelligent TechnologyLtd recorded an accrual ratio of 0.28. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of CN¥20.7m, a look at free cash flow indicates it actually burnt through CN¥144m in the last year. We also note that Zhejiang FORE Intelligent TechnologyLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥144m. Having said that, there is more to the story. 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 Zhejiang FORE Intelligent TechnologyLtd.

How Do Unusual Items Influence Profit?

Zhejiang FORE Intelligent TechnologyLtd's profit suffered from unusual items, which reduced profit by CN¥3.3m in the last twelve months. If this was a non-cash charge, it would have made the accrual ratio better, if cashflow had stayed strong, so it's not great to see in combination with an uninspiring accrual ratio. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. If Zhejiang FORE Intelligent TechnologyLtd doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Zhejiang FORE Intelligent TechnologyLtd's Profit Performance

Zhejiang FORE Intelligent TechnologyLtd saw unusual items weigh on its profit, which should have made it easier to show high cash conversion, which it did not do, according to its accrual ratio. Based on these factors, it's hard to tell if Zhejiang FORE Intelligent TechnologyLtd's profits are a reasonable reflection of its underlying profitability. So while earnings quality is important, it's equally important to consider the risks facing Zhejiang FORE Intelligent TechnologyLtd at this point in time. To help with this, we've discovered 4 warning signs (3 don't sit too well with us!) that you ought to be aware of before buying any shares in Zhejiang FORE Intelligent TechnologyLtd.

Our examination of Zhejiang FORE Intelligent TechnologyLtd has focussed on certain factors that can make its earnings look better than they are. 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.