Shareholders appeared unconcerned with Wuxi Hongsheng Heat Exchanger Manufacturing Co., Ltd.'s (SHSE:603090) lackluster earnings report last week. We think that the softer headline numbers might be getting counterbalanced by some positive underlying factors.

Examining Cashflow Against Wuxi Hongsheng Heat Exchanger Manufacturing's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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 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.

Wuxi Hongsheng Heat Exchanger Manufacturing has an accrual ratio of -0.12 for the year to September 2024. Therefore, its statutory earnings were quite a lot less than its free cashflow. In fact, it had free cash flow of CN¥111m in the last year, which was a lot more than its statutory profit of CN¥44.7m. Wuxi Hongsheng Heat Exchanger Manufacturing's free cash flow improved over the last year, which is generally good to see.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Wuxi Hongsheng Heat Exchanger Manufacturing.

Our Take On Wuxi Hongsheng Heat Exchanger Manufacturing's Profit Performance

Wuxi Hongsheng Heat Exchanger Manufacturing's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that Wuxi Hongsheng Heat Exchanger Manufacturing's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at an extremely impressive rate over the last three years. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. You'd be interested to know, that we found 2 warning signs for Wuxi Hongsheng Heat Exchanger Manufacturing and you'll want to know about these.

Today we've zoomed in on a single data point to better understand the nature of Wuxi Hongsheng Heat Exchanger Manufacturing'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. 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.