Investors signalled that they were pleased with China Lilang Limited's (HKG:1234) most recent earnings report. This reaction by the market reaction is understandable when looking at headline profits and we have found some further encouraging factors.

Examining Cashflow Against China Lilang'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. 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.

China Lilang has an accrual ratio of -0.12 for the year to December 2023. Therefore, its statutory earnings were quite a lot less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of CN¥967m, well over the CN¥530.4m it reported in profit. China Lilang shareholders are no doubt pleased that free cash flow improved over the last twelve months.

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.

Our Take On China Lilang's Profit Performance

China Lilang's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think China Lilang's earnings potential is at least as good as it seems, and maybe even better! And on top of that, its earnings per share increased by 18% 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. If you want to do dive deeper into China Lilang, you'd also look into what risks it is currently facing. At Simply Wall St, we found 1 warning sign for China Lilang and we think they deserve your attention.

This note has only looked at a single factor that sheds light on the nature of China Lilang'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.