Liuzhou Chemical Industry's (SHSE:600423) Conservative Accounting Might Explain Soft Earnings

Investors were disappointed with the weak earnings posted by Liuzhou Chemical Industry Co., Ltd. (SHSE:600423 ). However, our analysis suggests that the soft headline numbers are getting counterbalanced by some positive underlying factors.

A Closer Look At Liuzhou Chemical Industry's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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. 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 2024, Liuzhou Chemical Industry recorded an accrual ratio of -0.14. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of CN¥46m during the period, dwarfing its reported profit of CN¥30.2m. Liuzhou Chemical Industry shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Liuzhou Chemical Industry.

Our Take On Liuzhou Chemical Industry's Profit Performance

As we discussed above, Liuzhou Chemical Industry has perfectly satisfactory free cash flow relative to profit. Because of this, we think Liuzhou Chemical Industry's earnings potential is at least as good as it seems, and maybe even better! Unfortunately, though, its earnings per share actually fell back over the last year. 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. If you'd like to know more about Liuzhou Chemical Industry as a business, it's important to be aware of any risks it's facing. For example, we've discovered 2 warning signs that you should run your eye over to get a better picture of Liuzhou Chemical Industry.

This note has only looked at a single factor that sheds light on the nature of Liuzhou Chemical Industry's profit. But there are plenty of other ways to inform your opinion of a company. 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. 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 with significant insider holdings 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.