Flowing Cloud Technology Ltd's (HKG:6610) stock showed strength, with investors undeterred by its weak earnings report. Sometimes, shareholders are willing to ignore soft numbers with the hope that they will improve, but our analysis suggests this is unlikely for Flowing Cloud Technology.

Examining Cashflow Against Flowing Cloud Technology'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). 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. 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 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 June 2024, Flowing Cloud Technology had an accrual ratio of 0.37. 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. Even though it reported a profit of CN¥211.1m, a look at free cash flow indicates it actually burnt through CN¥250m in the last year. We also note that Flowing Cloud Technology's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥250m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Flowing Cloud Technology.

Our Take On Flowing Cloud Technology's Profit Performance

As we have made quite clear, we're a bit worried that Flowing Cloud Technology didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Flowing Cloud Technology's underlying earnings power is lower than its statutory profit. But the good news is that its EPS growth over the last three years has been very impressive. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you want to do dive deeper into Flowing Cloud Technology, you'd also look into what risks it is currently facing. To help with this, we've discovered 2 warning signs (1 is concerning!) that you ought to be aware of before buying any shares in Flowing Cloud Technology.

Today we've zoomed in on a single data point to better understand the nature of Flowing Cloud Technology's profit. 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 with high insider ownership.

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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.