Statutory Profit Doesn't Reflect How Good Chengdu Rainbow Appliance (Group) Shares' (SZSE:003023) Earnings Are

Chengdu Rainbow Appliance (Group) Shares Co., Ltd.'s (SZSE:003023) strong earnings report was rewarded with a positive stock price move. Our analysis found some more factors that we think are good for shareholders.

See our latest analysis for Chengdu Rainbow Appliance (Group) Shares

Zooming In On Chengdu Rainbow Appliance (Group) Shares' 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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to March 2024, Chengdu Rainbow Appliance (Group) Shares recorded an accrual ratio of -0.26. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of CN¥209m in the last year, which was a lot more than its statutory profit of CN¥112.7m. Chengdu Rainbow Appliance (Group) Shares' free cash flow improved over the last year, which is generally good to see.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Chengdu Rainbow Appliance (Group) Shares.

Our Take On Chengdu Rainbow Appliance (Group) Shares' Profit Performance

As we discussed above, Chengdu Rainbow Appliance (Group) Shares' accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Chengdu Rainbow Appliance (Group) Shares' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, its earnings per share increased by 15% in the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. So while earnings quality is important, it's equally important to consider the risks facing Chengdu Rainbow Appliance (Group) Shares at this point in time. Case in point: We've spotted 1 warning sign for Chengdu Rainbow Appliance (Group) Shares you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of Chengdu Rainbow Appliance (Group) Shares' profit. 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.