Gokul Refoils & Solvent's (NSE:GOKUL) Earnings Are Weaker Than They Seem

Investors were disappointed with Gokul Refoils & Solvent Limited's (NSE:GOKUL) earnings, despite the strong profit numbers. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.

View our latest analysis for Gokul Refoils & Solvent

A Closer Look At Gokul Refoils & Solvent's 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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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 September 2024, Gokul Refoils & Solvent had an accrual ratio of 0.24. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of ₹1.3b despite its profit of ₹115.7m, mentioned above. We also note that Gokul Refoils & Solvent's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹1.3b. 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 Gokul Refoils & Solvent.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Gokul Refoils & Solvent's profit was boosted by unusual items worth ₹39m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. If Gokul Refoils & Solvent doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Gokul Refoils & Solvent's Profit Performance

Summing up, Gokul Refoils & Solvent received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Gokul Refoils & Solvent's profits probably give an overly generous impression of its sustainable level of profitability. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For instance, we've identified 5 warning signs for Gokul Refoils & Solvent (3 are concerning) you should be familiar with.

Our examination of Gokul Refoils & Solvent has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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 with high insider ownership.

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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.