Fujian Nanwang Environment Protection Scien-Tech Co.,Ltd's (SZSE:301355) weak earnings were disregarded by the market. Despite the strength in the stock, we feel that investors should be cautious about some numbers in the earnings.

Examining Cashflow Against Fujian Nanwang Environment Protection Scien-TechLtd's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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.

Fujian Nanwang Environment Protection Scien-TechLtd has an accrual ratio of 0.23 for the year to September 2024. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of CN¥250m, in contrast to the aforementioned profit of CN¥53.8m. We saw that FCF was CN¥52m a year ago though, so Fujian Nanwang Environment Protection Scien-TechLtd has at least been able to generate positive FCF in the past. However, that's not all there is to consider. 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 Fujian Nanwang Environment Protection Scien-TechLtd.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Fujian Nanwang Environment Protection Scien-TechLtd's profit was boosted by unusual items worth CN¥9.9m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. Fujian Nanwang Environment Protection Scien-TechLtd had a rather significant contribution from unusual items relative to its profit to September 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 Fujian Nanwang Environment Protection Scien-TechLtd's Profit Performance

Summing up, Fujian Nanwang Environment Protection Scien-TechLtd received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Fujian Nanwang Environment Protection Scien-TechLtd's profits probably give an overly generous impression of its sustainable level of profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Every company has risks, and we've spotted 3 warning signs for Fujian Nanwang Environment Protection Scien-TechLtd (of which 1 is concerning!) you should know about.

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 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.