Last week's profit announcement from Suzhou West Deane New Power Electric Co.,Ltd. (SHSE:603312) was underwhelming for investors, despite headline numbers being robust. We did some digging and found some worrying underlying problems.

A Closer Look At Suzhou West Deane New Power ElectricLtd'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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to December 2023, Suzhou West Deane New Power ElectricLtd recorded an accrual ratio of 0.43. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥45m despite its profit of CN¥198.1m, mentioned above. We also note that Suzhou West Deane New Power ElectricLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥45m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Suzhou West Deane New Power ElectricLtd.

Our Take On Suzhou West Deane New Power ElectricLtd's Profit Performance

As we discussed above, we think Suzhou West Deane New Power ElectricLtd's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Suzhou West Deane New Power ElectricLtd's underlying earnings power is lower than its statutory profit. The good news is that, its earnings per share increased by 28% in the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it's equally important to consider the risks facing Suzhou West Deane New Power ElectricLtd at this point in time. For example, we've found that Suzhou West Deane New Power ElectricLtd has 2 warning signs (1 can't be ignored!) that deserve your attention before going any further with your analysis.

This note has only looked at a single factor that sheds light on the nature of Suzhou West Deane New Power ElectricLtd's profit. 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. 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.