Zhejiang Biyi Electric Appliance Co., Ltd. (SHSE:603215) recently posted soft earnings but shareholders didn't react strongly. Our analysis suggests that they may be missing some concerning details underlying the profit numbers.

A Closer Look At Zhejiang Biyi Electric Appliance'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. 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.

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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Zhejiang Biyi Electric Appliance has an accrual ratio of 0.48 for the year to June 2024. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of CN¥142.7m, a look at free cash flow indicates it actually burnt through CN¥181m in the last year. It's worth noting that Zhejiang Biyi Electric Appliance generated positive FCF of CN¥255m a year ago, so at least they've done it 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. The good news for shareholders is that Zhejiang Biyi Electric Appliance's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. 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.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Zhejiang Biyi Electric Appliance's profit was boosted by unusual items worth CN¥11m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. If Zhejiang Biyi Electric Appliance doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Zhejiang Biyi Electric Appliance's Profit Performance

Zhejiang Biyi Electric Appliance had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Zhejiang Biyi Electric Appliance's profits probably give an overly generous impression of its sustainable level of profitability. 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. Every company has risks, and we've spotted 3 warning signs for Zhejiang Biyi Electric Appliance (of which 1 makes us a bit uncomfortable!) 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 are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.

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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.