Fabryka Farb i Lakierów Sniezka's (WSE:SKA) Conservative Accounting Might Explain Soft Earnings

The market shrugged off the recent earnings report from Fabryka Farb i Lakierów Sniezka SA (WSE:SKA), despite the profit numbers being soft. We think that investors might be looking at some positive factors beyond the earnings numbers.

See our latest analysis for Fabryka Farb i Lakierów Sniezka

Examining Cashflow Against Fabryka Farb i Lakierów Sniezka'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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to December 2021, Fabryka Farb i Lakierów Sniezka recorded an accrual ratio of -0.11. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of zł124m during the period, dwarfing its reported profit of zł59.7m. Notably, Fabryka Farb i Lakierów Sniezka had negative free cash flow last year, so the zł124m it produced this year was a welcome improvement.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Fabryka Farb i Lakierów Sniezka.

Our Take On Fabryka Farb i Lakierów Sniezka's Profit Performance

As we discussed above, Fabryka Farb i Lakierów Sniezka has perfectly satisfactory free cash flow relative to profit. Because of this, we think Fabryka Farb i Lakierów Sniezka's earnings potential is at least as good as it seems, and maybe even better! On the other hand, its EPS actually shrunk in the last twelve months. 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 Fabryka Farb i Lakierów Sniezka at this point in time. Case in point: We've spotted 2 warning signs for Fabryka Farb i Lakierów Sniezka you should be aware of.

This note has only looked at a single factor that sheds light on the nature of Fabryka Farb i Lakierów Sniezka'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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.