Systems Engineering ConsultantsLTD's (TSE:3741) Profits Appear To Have Quality Issues

Systems Engineering Consultants Co.,LTD.'s (TSE:3741) healthy profit numbers didn't contain any surprises for investors. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

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Zooming In On Systems Engineering ConsultantsLTD's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 2025, Systems Engineering ConsultantsLTD had an accrual ratio of 0.26. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of JP¥289m, in contrast to the aforementioned profit of JP¥1.34b. We saw that FCF was JP¥346m a year ago though, so Systems Engineering ConsultantsLTD 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 Systems Engineering ConsultantsLTD.

Our Take On Systems Engineering ConsultantsLTD's Profit Performance

Systems Engineering ConsultantsLTD didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Systems Engineering ConsultantsLTD's statutory profits are better than its underlying earnings power. But the good news is that its EPS growth over the last three years has been very impressive. 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 while earnings quality is important, it's equally important to consider the risks facing Systems Engineering ConsultantsLTD at this point in time. Case in point: We've spotted 1 warning sign for Systems Engineering ConsultantsLTD you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of Systems Engineering ConsultantsLTD'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 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.