Investors Can Find Comfort In Fujian Yongan Forestry(Group)Ltd's (SZSE:000663) Earnings Quality

Shareholders appeared unconcerned with Fujian Yongan Forestry(Group)Joint-Stock Co.,Ltd.'s (SZSE:000663) lackluster earnings report last week. We did some digging, and we believe the earnings are stronger than they seem.

View our latest analysis for Fujian Yongan Forestry(Group)Ltd

Zooming In On Fujian Yongan Forestry(Group)Ltd'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. 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'.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to March 2024, Fujian Yongan Forestry(Group)Ltd had an accrual ratio of 0.29. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Over the last year it actually had negative free cash flow of CN¥143m, in contrast to the aforementioned profit of CN¥126.9m. We saw that FCF was CN¥400m a year ago though, so Fujian Yongan Forestry(Group)Ltd has at least been able to generate positive FCF in the past. 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. The good news for shareholders is that Fujian Yongan Forestry(Group)Ltd's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Fujian Yongan Forestry(Group)Ltd.

How Do Unusual Items Influence Profit?

Unfortunately (in the short term) Fujian Yongan Forestry(Group)Ltd saw its profit reduced by unusual items worth CN¥66m. 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, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect Fujian Yongan Forestry(Group)Ltd to produce a higher profit next year, all else being equal.

Our Take On Fujian Yongan Forestry(Group)Ltd's Profit Performance

In conclusion, Fujian Yongan Forestry(Group)Ltd's accrual ratio suggests that its statutory earnings are not backed by cash flow, even though unusual items weighed on profit. Given the contrasting considerations, we don't have a strong view as to whether Fujian Yongan Forestry(Group)Ltd's profits are an apt reflection of its underlying potential for profit. If you want to do dive deeper into Fujian Yongan Forestry(Group)Ltd, you'd also look into what risks it is currently facing. For example, we've found that Fujian Yongan Forestry(Group)Ltd has 2 warning signs (1 is a bit concerning!) that deserve your attention before going any further with your analysis.

Our examination of Fujian Yongan Forestry(Group)Ltd has focussed on certain factors that can make its earnings look better than they are. 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. 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.