We Like Caffyns' (LON:CFYN) Earnings For More Than Just Statutory Profit

The market seemed underwhelmed by last week's earnings announcement from Caffyns plc (LON:CFYN) despite the healthy numbers. Our analysis suggests that shareholders might be missing some positive underlying factors in the earnings report.

See our latest analysis for Caffyns

A Closer Look At Caffyns' 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). 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 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".

Caffyns has an accrual ratio of -0.10 for the year to March 2021. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of UK£6.3m during the period, dwarfing its reported profit of UK£1.41m. Notably, Caffyns had negative free cash flow last year, so the UK£6.3m it produced this year was a welcome improvement.

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

Our Take On Caffyns' Profit Performance

Caffyns' accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Caffyns' earnings potential is at least as good as it seems, and maybe even better! And it's also positive that the company showed enough improvement to book a profit this year, after losing money last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. So while earnings quality is important, it's equally important to consider the risks facing Caffyns at this point in time. To that end, you should learn about the 3 warning signs we've spotted with Caffyns (including 2 which can't be ignored).

Today we've zoomed in on a single data point to better understand the nature of Caffyns' profit. 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. 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.
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