Earnings Troubles May Signal Larger Issues for Shenzhen hongfuhan Technology (SZSE:301086) Shareholders

The subdued market reaction suggests that Shenzhen hongfuhan Technology Co. Ltd.'s (SZSE:301086) recent earnings didn't contain any surprises. Our analysis suggests that along with soft profit numbers, investors should be aware of some other underlying weaknesses in the numbers.

See our latest analysis for Shenzhen hongfuhan Technology

Zooming In On Shenzhen hongfuhan Technology's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. 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, Shenzhen hongfuhan Technology had an accrual ratio of 0.30. 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¥254m, in contrast to the aforementioned profit of CN¥98.0m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥254m, this year, indicates high risk. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shenzhen hongfuhan Technology.

How Do Unusual Items Influence Profit?

Unfortunately (in the short term) Shenzhen hongfuhan Technology saw its profit reduced by unusual items worth CN¥18m. 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. 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. Assuming those unusual expenses don't come up again, we'd therefore expect Shenzhen hongfuhan Technology to produce a higher profit next year, all else being equal.

Our Take On Shenzhen hongfuhan Technology's Profit Performance

Shenzhen hongfuhan Technology saw unusual items weigh on its profit, which should have made it easier to show high cash conversion, which it did not do, according to its accrual ratio. Based on these factors, we think it's very unlikely that Shenzhen hongfuhan Technology's statutory profits make it seem much weaker than it is. If you'd like to know more about Shenzhen hongfuhan Technology as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 3 warning signs for Shenzhen hongfuhan Technology you should be mindful of and 1 of these bad boys is potentially serious.

Our examination of Shenzhen hongfuhan Technology has focussed on certain factors that can make its earnings look better than they are. 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.