A lackluster earnings announcement from Yinchuan Weili Transmission Technology Co., Ltd. (SZSE:300904) last week didn't sink the stock price. However, we believe that investors should be aware of some underlying factors which may be of concern.

Examining Cashflow Against Yinchuan Weili Transmission Technology's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. 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 December 2023, Yinchuan Weili Transmission Technology had an accrual ratio of 0.42. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥249m despite its profit of CN¥41.2m, mentioned above. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥249m, this year, indicates high risk. 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 Yinchuan Weili Transmission Technology.

How Do Unusual Items Influence Profit?

Unfortunately (in the short term) Yinchuan Weili Transmission Technology saw its profit reduced by unusual items worth CN¥7.8m. If this was a non-cash charge, it would have made the accrual ratio better, if cashflow had stayed strong, so it's not great to see in combination with an uninspiring accrual ratio. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. 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. Assuming those unusual expenses don't come up again, we'd therefore expect Yinchuan Weili Transmission Technology to produce a higher profit next year, all else being equal.

Our Take On Yinchuan Weili Transmission Technology's Profit Performance

In conclusion, Yinchuan Weili Transmission Technology's accrual ratio suggests that its statutory earnings are not backed by cash flow, even though unusual items weighed on profit. Having considered these factors, we don't think Yinchuan Weili Transmission Technology's statutory profits give an overly harsh view of the business. If you want to do dive deeper into Yinchuan Weili Transmission Technology, you'd also look into what risks it is currently facing. When we did our research, we found 4 warning signs for Yinchuan Weili Transmission Technology (2 don't sit too well with us!) that we believe deserve your full attention.

Our examination of Yinchuan Weili Transmission Technology has focussed on certain factors that can make its earnings look better than they are. 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 that insiders are buying.

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.