Last week's profit announcement from Guangzhou Risong Intelligent Technology Holding Co., Ltd. (SHSE:688090) was underwhelming for investors, despite headline numbers being robust. We did some digging and found some worrying underlying problems.

A Closer Look At Guangzhou Risong Intelligent Technology Holding'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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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.

For the year to September 2024, Guangzhou Risong Intelligent Technology Holding had an accrual ratio of -0.11. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. In fact, it had free cash flow of CN¥110m in the last year, which was a lot more than its statutory profit of CN¥34.1m. Given that Guangzhou Risong Intelligent Technology Holding had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥110m would seem to be a step in the right direction. 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Guangzhou Risong Intelligent Technology Holding.

The Impact Of Unusual Items On Profit

While the accrual ratio might bode well, we also note that Guangzhou Risong Intelligent Technology Holding's profit was boosted by unusual items worth CN¥22m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. Guangzhou Risong Intelligent Technology Holding had a rather significant contribution from unusual items relative to its profit to September 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Guangzhou Risong Intelligent Technology Holding's Profit Performance

Guangzhou Risong Intelligent Technology Holding'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. Having considered these factors, we don't think Guangzhou Risong Intelligent Technology Holding's statutory profits give an overly harsh view of the business. If you want to do dive deeper into Guangzhou Risong Intelligent Technology Holding, you'd also look into what risks it is currently facing. To help with this, we've discovered 3 warning signs (2 shouldn't be ignored!) that you ought to be aware of before buying any shares in Guangzhou Risong Intelligent Technology Holding.

Our examination of Guangzhou Risong Intelligent Technology Holding 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. 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.

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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.