There May Be Underlying Issues With The Quality Of Innovana Thinklabs' (NSE:INNOVANA) Earnings

Despite announcing strong earnings, Innovana Thinklabs Limited's (NSE:INNOVANA) stock was sluggish. We think that the market might be paying attention to some underlying factors that they find to be concerning.

View our latest analysis for Innovana Thinklabs

Zooming In On Innovana Thinklabs' 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.

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.

For the year to March 2024, Innovana Thinklabs had an accrual ratio of 0.39. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of ₹125m, in contrast to the aforementioned profit of ₹412.6m. We saw that FCF was ₹526k a year ago though, so Innovana Thinklabs has at least been able to generate positive FCF in the past.

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

Our Take On Innovana Thinklabs' Profit Performance

As we have made quite clear, we're a bit worried that Innovana Thinklabs didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Innovana Thinklabs' underlying earnings power is lower than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. 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. If you want to do dive deeper into Innovana Thinklabs, you'd also look into what risks it is currently facing. In terms of investment risks, we've identified 2 warning signs with Innovana Thinklabs, and understanding them should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of Innovana Thinklabs' 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 with significant insider holdings to be useful.

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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.