Man King Holdings Limited's (HKG:2193) earnings announcement last week didn't impress shareholders. Despite the soft profit numbers, our analysis has optimistic about the overall quality of the income statement.

See our latest analysis for Man King Holdings

Zooming In On Man King Holdings' 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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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.

For the year to September 2023, Man King Holdings had an accrual ratio of -0.16. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of HK$36m during the period, dwarfing its reported profit of HK$18.3m. Man King Holdings' free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Man King Holdings.

How Do Unusual Items Influence Profit?

Surprisingly, given Man King Holdings' accrual ratio implied strong cash conversion, its paper profit was actually boosted by HK$109k in unusual items. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. 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. Which is hardly surprising, given the name. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Man King Holdings' Profit Performance

Man King Holdings' profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Considering all the aforementioned, we'd venture that Man King Holdings' profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. While conducting our analysis, we found that Man King Holdings has 3 warning signs and it would be unwise to ignore these.

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. 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 that insiders are buying 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.