Jiangsu Leadmicro Nano-Equipment Technology Ltd's (SHSE:688147) robust earnings report didn't manage to move the market for its stock. We did some digging, and we found some concerning factors in the details.

A Closer Look At Jiangsu Leadmicro Nano-Equipment 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to March 2024, Jiangsu Leadmicro Nano-Equipment Technology had an accrual ratio of 0.49. 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. Even though it reported a profit of CN¥275.1m, a look at free cash flow indicates it actually burnt through CN¥575m in the last year. We saw that FCF was CN¥116m a year ago though, so Jiangsu Leadmicro Nano-Equipment Technology has at least been able to generate positive FCF in the past. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio. One positive for Jiangsu Leadmicro Nano-Equipment Technology shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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.

How Do Unusual Items Influence Profit?

Unfortunately (in the short term) Jiangsu Leadmicro Nano-Equipment Technology saw its profit reduced by unusual items worth CN¥80m. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect Jiangsu Leadmicro Nano-Equipment Technology to produce a higher profit next year, all else being equal.

Our Take On Jiangsu Leadmicro Nano-Equipment Technology's Profit Performance

Jiangsu Leadmicro Nano-Equipment Technology saw unusual items weigh on its profit, which should have made it easier to show high cash conversion, which it did not do, according to its accrual ratio. Having considered these factors, we don't think Jiangsu Leadmicro Nano-Equipment Technology's statutory profits give an overly harsh view of the business. So while earnings quality is important, it's equally important to consider the risks facing Jiangsu Leadmicro Nano-Equipment Technology at this point in time. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of Jiangsu Leadmicro Nano-Equipment Technology.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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.