Jinhua Chunguang TechnologyLtd's (SHSE:603657) Soft Earnings Don't Show The Whole Picture

Investors were disappointed with the weak earnings posted by Jinhua Chunguang Technology Co.,Ltd (SHSE:603657 ). Despite the soft profit numbers, our analysis has optimistic about the overall quality of the income statement.

Check out our latest analysis for Jinhua Chunguang TechnologyLtd

Examining Cashflow Against Jinhua Chunguang 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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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 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 December 2023, Jinhua Chunguang TechnologyLtd recorded an accrual ratio of 0.27. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of CN¥155m, in contrast to the aforementioned profit of CN¥25.0m. It's worth noting that Jinhua Chunguang TechnologyLtd generated positive FCF of CN¥235m a year ago, so at least they've done it in the past. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part. One positive for Jinhua Chunguang TechnologyLtd shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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.

The Impact Of Unusual Items On Profit

Jinhua Chunguang TechnologyLtd's profit suffered from unusual items, which reduced profit by CN¥16m 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. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. If Jinhua Chunguang 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 Jinhua Chunguang TechnologyLtd's Profit Performance

In conclusion, Jinhua Chunguang TechnologyLtd's accrual ratio suggests that its statutory earnings are not backed by cash flow, even though unusual items weighed on profit. Considering the aforementioned, we think that Jinhua Chunguang TechnologyLtd's profits are probably a reasonable reflection of its underlying profitability; although we'd be confident in that conclusion if we saw a cleaner set of results. So while earnings quality is important, it's equally important to consider the risks facing Jinhua Chunguang TechnologyLtd at this point in time. For example, we've found that Jinhua Chunguang TechnologyLtd has 4 warning signs (2 don't sit too well with us!) that deserve your attention before going any further with your analysis.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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.