Cadsys (India)'s (NSE:CADSYS) Earnings Are Of Questionable Quality

Despite announcing strong earnings, Cadsys (India) Limited's (NSE:CADSYS) stock was sluggish. We did some digging and found some worrying underlying problems.

See our latest analysis for Cadsys (India)

Zooming In On Cadsys (India)'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. 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.

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

For the year to September 2023, Cadsys (India) had an accrual ratio of 0.85. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of ₹137.3m, a look at free cash flow indicates it actually burnt through ₹1.2b in the last year. We also note that Cadsys (India)'s free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹1.2b.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Cadsys (India).

Our Take On Cadsys (India)'s Profit Performance

As we have made quite clear, we're a bit worried that Cadsys (India) didn't back up the last year's profit with free cashflow. For this reason, we think that Cadsys (India)'s statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The good news is that it earned a profit in the last twelve months, despite its previous loss. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Case in point: We've spotted 5 warning signs for Cadsys (India) you should be mindful of and 4 of them are significant.

This note has only looked at a single factor that sheds light on the nature of Cadsys (India)'s profit. 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.