Investors Can Find Comfort In Telink Semiconductor(Shanghai)Co.Ltd's (SHSE:688591) Earnings Quality

Telink Semiconductor(Shanghai)Co.,Ltd.'s (SHSE:688591) earnings announcement last week didn't impress shareholders. Despite the soft profit numbers, our analysis has optimistic about the overall quality of the income statement.

See our latest analysis for Telink Semiconductor(Shanghai)Co.Ltd

Examining Cashflow Against Telink Semiconductor(Shanghai)Co.Ltd's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. The ratio shows us how much a company's profit exceeds its FCF.

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 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Telink Semiconductor(Shanghai)Co.Ltd has an accrual ratio of -0.18 for the year to March 2024. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of CN¥114m during the period, dwarfing its reported profit of CN¥37.0m. Telink Semiconductor(Shanghai)Co.Ltd shareholders are no doubt pleased that free cash flow improved over the last twelve months. However, we can see that a recent tax benefit, along with unusual items, have impacted its statutory profit, and therefore its accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Telink Semiconductor(Shanghai)Co.Ltd.

The Impact Of Unusual Items On Profit

Telink Semiconductor(Shanghai)Co.Ltd's profit was reduced by unusual items worth CN¥8.9m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. In the twelve months to March 2024, Telink Semiconductor(Shanghai)Co.Ltd had a big unusual items expense. All else being equal, this would likely have the effect of making the statutory profit look worse than its underlying earnings power.

An Unusual Tax Situation

In addition to the notable accrual ratio, we can see that Telink Semiconductor(Shanghai)Co.Ltd received a tax benefit of CN¥1.5m. This is meaningful because companies usually pay tax rather than receive tax benefits. We're sure the company was pleased with its tax benefit. However, our data indicates that tax benefits can temporarily boost statutory profit in the year it is booked, but subsequently profit may fall back. In the likely event the tax benefit is not repeated, we'd expect to see its statutory profit levels drop, at least in the absence of strong growth. So while we think it's great to receive a tax benefit, it does tend to imply an increased risk that the statutory profit overstates the sustainable earnings power of the business.

Our Take On Telink Semiconductor(Shanghai)Co.Ltd's Profit Performance

Summing up, Telink Semiconductor(Shanghai)Co.Ltd's accrual ratio and its unusual items suggest that its statutory earnings were temporarily depressed, while its tax benefit is having the opposite effect. Based on these factors, we think Telink Semiconductor(Shanghai)Co.Ltd's earnings potential is at least as good as it seems, and maybe even better! 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 Telink Semiconductor(Shanghai)Co.Ltd's balance sheet health here.

Our examination of Telink Semiconductor(Shanghai)Co.Ltd has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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 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.