R S Software (India)'s (NSE:RSSOFTWARE) Earnings Are Of Questionable Quality

Investors were disappointed with R S Software (India) Limited's (NSE:RSSOFTWARE) earnings, despite the strong profit numbers. We think that the market might be paying attention to some underlying factors that they find to be concerning.

Check out our latest analysis for R S Software (India)

A Closer Look At R S Software (India)'s Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. 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".

R S Software (India) has an accrual ratio of 0.66 for the year to September 2024. That means it didn't generate anywhere near enough free cash flow to match its profit. Statistically speaking, that's a real negative for future earnings. To wit, it produced free cash flow of ₹31m during the period, falling well short of its reported profit of ₹242.4m. Given that R S Software (India) had negative free cash flow in the prior corresponding period, the trailing twelve month resul of ₹31m would seem to be a step in the right direction.

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

Our Take On R S Software (India)'s Profit Performance

As we have made quite clear, we're a bit worried that R S Software (India) didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that R S Software (India)'s underlying earnings power is lower than its statutory profit. The silver lining is that its EPS growth over the last year has been really wonderful, even if it's not a perfect measure. 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. So while earnings quality is important, it's equally important to consider the risks facing R S Software (India) at this point in time. Every company has risks, and we've spotted 2 warning signs for R S Software (India) (of which 1 is concerning!) you should know about.

Today we've zoomed in on a single data point to better understand the nature of R S Software (India)'s 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.