Investors signalled that they were pleased with Shenzhen Bestek Technology Co., Ltd.'s (SZSE:300822) most recent earnings report. According to our analysis of the report, the strong headline profit numbers are supported by strong earnings fundamentals.

A Closer Look At Shenzhen Bestek 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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 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 December 2023, Shenzhen Bestek Technology had an accrual ratio of -0.16. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of CN¥177m during the period, dwarfing its reported profit of CN¥47.6m. Shenzhen Bestek Technology shareholders are no doubt pleased that free cash flow improved over the last twelve months. 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shenzhen Bestek Technology.

How Do Unusual Items Influence Profit?

Shenzhen Bestek Technology's profit was reduced by unusual items worth CN¥19m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. 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 that's hardly a surprise given these line items are considered unusual. If Shenzhen Bestek Technology doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Shenzhen Bestek Technology's Profit Performance

In conclusion, both Shenzhen Bestek Technology's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. After considering all this, we reckon Shenzhen Bestek Technology's statutory profit probably understates its earnings potential! If you'd like to know more about Shenzhen Bestek Technology as a business, it's important to be aware of any risks it's facing. Be aware that Shenzhen Bestek Technology is showing 4 warning signs in our investment analysis and 2 of those are a bit unpleasant...

Our examination of Shenzhen Bestek Technology has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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 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.