The recent earnings release from Shanghai CEO Environmental Protection Technology Co., Ltd (SHSE:688335 ) was disappointing to investors. We think there is more to the story than simply soft profit numbers. Our analysis shows that there are some other factors of concern.

Examining Cashflow Against Shanghai CEO Environmental Protection 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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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.

Over the twelve months to March 2024, Shanghai CEO Environmental Protection Technology recorded an accrual ratio of 0.40. As a general rule, that bodes poorly for future profitability. 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¥155m despite its profit of CN¥68.1m, mentioned above. It's worth noting that Shanghai CEO Environmental Protection Technology generated positive FCF of CN¥1.5m a year ago, so at least they've done it in the past. 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.

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.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by CN¥14m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. Shanghai CEO Environmental Protection Technology had a rather significant contribution from unusual items relative to its profit to March 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 Shanghai CEO Environmental Protection Technology's Profit Performance

Shanghai CEO Environmental Protection Technology had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at Shanghai CEO Environmental Protection Technology's statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Shanghai CEO Environmental Protection Technology, you'd also look into what risks it is currently facing. Case in point: We've spotted 3 warning signs for Shanghai CEO Environmental Protection Technology you should be mindful of and 1 of these is significant.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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.

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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.