The market wasn't impressed with the soft earnings from Shanghai Yizhong Pharmaceutical Co., Ltd. (SHSE:688091) recently. Our analysis has found some reasons to be concerned, beyond the weak headline numbers.

Zooming In On Shanghai Yizhong Pharmaceutical'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). 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.

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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to March 2024, Shanghai Yizhong Pharmaceutical had an accrual ratio of 0.22. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. In fact, it had free cash flow of CN¥74m in the last year, which was a lot less than its statutory profit of CN¥135.7m. Shanghai Yizhong Pharmaceutical shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shanghai Yizhong Pharmaceutical.

Our Take On Shanghai Yizhong Pharmaceutical's Profit Performance

Shanghai Yizhong Pharmaceutical's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that Shanghai Yizhong Pharmaceutical's statutory profits are better than its underlying earnings power. In further bad news, its earnings per share decreased 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For instance, we've identified 2 warning signs for Shanghai Yizhong Pharmaceutical (1 is significant) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Shanghai Yizhong Pharmaceutical's profit. 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.