Are Alfa Financial Software Holdings's (LON:ALFA) Statutory Earnings A Good Reflection Of Its Earnings Potential?

Broadly speaking, profitable businesses are less risky than unprofitable ones. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. This article will consider whether Alfa Financial Software Holdings' (LON:ALFA) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Alfa Financial Software Holdings made a profit of UK£14.0m on revenue of UK£71.8m. As depicted below, while its revenue may have fallen over the last few years, its profit actually improved.

Check out our latest analysis for Alfa Financial Software Holdings

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. As a result, we think it's well worth considering what Alfa Financial Software Holdings' cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Examining Cashflow Against Alfa Financial Software Holdings' 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. 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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.

Alfa Financial Software Holdings has an accrual ratio of -0.11 for the year to June 2020. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. In fact, it had free cash flow of UK£17m in the last year, which was a lot more than its statutory profit of UK£14.0m. Alfa Financial Software Holdings' free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons.

Our Take On Alfa Financial Software Holdings' Profit Performance

As we discussed above, Alfa Financial Software Holdings has perfectly satisfactory free cash flow relative to profit. Because of this, we think Alfa Financial Software Holdings' earnings potential is at least as good as it seems, and maybe even better! And on top of that, its earnings per share have grown at 26% per year over the last three years. 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 if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. At Simply Wall St, we found 1 warning sign for Alfa Financial Software Holdings and we think they deserve your attention.

This note has only looked at a single factor that sheds light on the nature of Alfa Financial Software Holdings' 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. 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 that insiders are buying to be useful.

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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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