Tsann Kuen (China) Enterprise Co., Ltd.'s (SZSE:200512) robust recent earnings didn't do much to move the stock. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

Examining Cashflow Against Tsann Kuen (China) Enterprise'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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the 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. 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. 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 2024, Tsann Kuen (China) Enterprise recorded an accrual ratio of -0.12. That indicates that its free cash flow was a fair bit more than its statutory profit. In fact, it had free cash flow of CN¥156m in the last year, which was a lot more than its statutory profit of CN¥92.6m. Tsann Kuen (China) Enterprise's free cash flow improved over the last year, which is generally good to see. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Tsann Kuen (China) Enterprise.

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that Tsann Kuen (China) Enterprise's profit was boosted by unusual items worth CN¥18m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And, after all, that's exactly what the accounting terminology implies. If Tsann Kuen (China) Enterprise doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Tsann Kuen (China) Enterprise's Profit Performance

Tsann Kuen (China) Enterprise's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Given the contrasting considerations, we don't have a strong view as to whether Tsann Kuen (China) Enterprise's profits are an apt reflection of its underlying potential for profit. If you want to do dive deeper into Tsann Kuen (China) Enterprise, you'd also look into what risks it is currently facing. Be aware that Tsann Kuen (China) Enterprise is showing 3 warning signs in our investment analysis and 1 of those can't be ignored...

Our examination of Tsann Kuen (China) Enterprise has focussed on certain factors that can make its earnings look better than they are. But there are plenty of other ways to inform your opinion of a company. 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.