Investors Can Find Comfort In Cadence Design Systems' (NASDAQ:CDNS) Earnings Quality

Soft earnings didn't appear to concern Cadence Design Systems, Inc.'s (NASDAQ:CDNS) shareholders over the last week. Our analysis suggests that while the profits are soft, the foundations of the business are strong.

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Examining Cashflow Against Cadence Design Systems' 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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.

Cadence Design Systems has an accrual ratio of -0.13 for the year to June 2025. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. To wit, it produced free cash flow of US$1.6b during the period, dwarfing its reported profit of US$1.01b. Cadence Design Systems shareholders are no doubt pleased that free cash flow improved over the last twelve months.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Cadence Design Systems' Profit Performance

Cadence Design Systems' accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Cadence Design Systems' earnings potential is at least as good as it seems, and maybe even better! And the EPS is up 31% annually, 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. Ultimately, this article has formed an opinion based on historical data. However, it can also be great to think about what analysts are forecasting for the future. At Simply Wall St, we have analyst estimates which you can view by clicking here.

This note has only looked at a single factor that sheds light on the nature of Cadence Design Systems' 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.