Investors were disappointed with the weak earnings posted by Yinsheng Digifavor Company Limited (HKG:3773 ). Despite the soft profit numbers, our analysis has optimistic about the overall quality of the income statement.

Zooming In On Yinsheng Digifavor'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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 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.

Over the twelve months to December 2023, Yinsheng Digifavor recorded an accrual ratio of -0.37. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of CN¥116m in the last year, which was a lot more than its statutory profit of CN¥16.4m. Notably, Yinsheng Digifavor had negative free cash flow last year, so the CN¥116m it produced this year was a welcome improvement.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Yinsheng Digifavor.

Our Take On Yinsheng Digifavor's Profit Performance

Happily for shareholders, Yinsheng Digifavor produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Yinsheng Digifavor's statutory profit actually understates its earnings potential! On the other hand, its EPS actually shrunk in the last twelve months. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you'd like to know more about Yinsheng Digifavor as a business, it's important to be aware of any risks it's facing. You'd be interested to know, that we found 1 warning sign for Yinsheng Digifavor and you'll want to know about it.

Today we've zoomed in on a single data point to better understand the nature of Yinsheng Digifavor's profit. 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.