Zhejiang Jiaxin SilkLtd's (SZSE:002404) Solid Earnings Have Been Accounted For Conservatively

Zhejiang Jiaxin Silk Corp.,Ltd.'s (SZSE:002404) recent earnings report didn't offer any surprises, with the shares unchanged over the last week. We did some digging, and we think that investors are missing some encouraging factors in the underlying numbers.

View our latest analysis for Zhejiang Jiaxin SilkLtd

Examining Cashflow Against Zhejiang Jiaxin SilkLtd'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). 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. 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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Zhejiang Jiaxin SilkLtd has an accrual ratio of -0.11 for the year to September 2024. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of CN¥423m during the period, dwarfing its reported profit of CN¥200.4m. Zhejiang Jiaxin SilkLtd's free cash flow improved over the last year, which is generally good to see. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zhejiang Jiaxin SilkLtd.

How Do Unusual Items Influence Profit?

Surprisingly, given Zhejiang Jiaxin SilkLtd's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥15m in unusual items. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. If Zhejiang Jiaxin SilkLtd doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Zhejiang Jiaxin SilkLtd's Profit Performance

Zhejiang Jiaxin SilkLtd's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Given the contrasting considerations, we don't have a strong view as to whether Zhejiang Jiaxin SilkLtd's profits are an apt reflection of its underlying potential for profit. While it's very important to consider the profit and loss statement, you can also learn a lot about a company by looking at its balance sheet. You can see our latest analysis on Zhejiang Jiaxin SilkLtd's balance sheet health here.

Our examination of Zhejiang Jiaxin SilkLtd 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. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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.