Shareholders Will Be Pleased With The Quality of NextgenInc's (TSE:3842) Earnings

Even though Nextgen,Inc. (TSE:3842 ) posted strong earnings, investors appeared to be underwhelmed. We have done some analysis and have found some comforting factors beneath the profit numbers.

We've discovered 1 warning sign about NextgenInc. View them for free.

Examining Cashflow Against NextgenInc'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to March 2025, NextgenInc recorded an accrual ratio of -0.38. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of JP¥587m during the period, dwarfing its reported profit of JP¥204.0m. NextgenInc's free cash flow improved over the last year, which is generally good to see. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Check out our latest analysis for NextgenInc

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

The Impact Of Unusual Items On Profit

NextgenInc's profit was reduced by unusual items worth JP¥32m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. If NextgenInc doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On NextgenInc's Profit Performance

Considering both NextgenInc's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. After considering all this, we reckon NextgenInc's statutory profit probably understates its earnings potential! So while earnings quality is important, it's equally important to consider the risks facing NextgenInc at this point in time. You'd be interested to know, that we found 1 warning sign for NextgenInc and you'll want to know about it.

Our examination of NextgenInc has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.