Inner Mongolia Xinhua Distribution GroupLtd (SHSE:603230) Posted Weak Earnings But There Is More To Worry About

Shareholders didn't appear too concerned by Inner Mongolia Xinhua Distribution Group Co.,Ltd.'s (SHSE:603230) weak earnings. We did some analysis and found some concerning details beneath the statutory profit number.

View our latest analysis for Inner Mongolia Xinhua Distribution GroupLtd

A Closer Look At Inner Mongolia Xinhua Distribution GroupLtd's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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".

Inner Mongolia Xinhua Distribution GroupLtd has an accrual ratio of 1.39 for the year to September 2024. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥195m despite its profit of CN¥280.9m, mentioned above. We saw that FCF was CN¥390m a year ago though, so Inner Mongolia Xinhua Distribution GroupLtd has at least been able to generate positive FCF 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. The good news for shareholders is that Inner Mongolia Xinhua Distribution GroupLtd'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. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Inner Mongolia Xinhua Distribution GroupLtd.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Inner Mongolia Xinhua Distribution GroupLtd's profit was boosted by unusual items worth CN¥42m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. If Inner Mongolia Xinhua Distribution GroupLtd 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 Inner Mongolia Xinhua Distribution GroupLtd's Profit Performance

Inner Mongolia Xinhua Distribution GroupLtd had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Inner Mongolia Xinhua Distribution GroupLtd's profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into Inner Mongolia Xinhua Distribution GroupLtd, you'd also look into what risks it is currently facing. To help with this, we've discovered 2 warning signs (1 is potentially serious!) that you ought to be aware of before buying any shares in Inner Mongolia Xinhua Distribution GroupLtd.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. 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.