Zhejiang Hongchang Electrical Technology Co., Ltd.'s (SZSE:301008) robust earnings report didn't manage to move the market for its stock. We did some digging, and we found some concerning factors in the details.

Examining Cashflow Against Zhejiang Hongchang Electrical Technology'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. 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. 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 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Zhejiang Hongchang Electrical Technology has an accrual ratio of 0.21 for the year to June 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Over the last year it actually had negative free cash flow of CN¥68m, in contrast to the aforementioned profit of CN¥84.4m. We also note that Zhejiang Hongchang Electrical Technology's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥68m.

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

Our Take On Zhejiang Hongchang Electrical Technology's Profit Performance

Zhejiang Hongchang Electrical Technology didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Zhejiang Hongchang Electrical Technology's true underlying earnings power is actually less than its statutory profit. The good news is that, its earnings per share increased by 21% in the last year. 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 Zhejiang Hongchang Electrical Technology as a business, it's important to be aware of any risks it's facing. For example, we've found that Zhejiang Hongchang Electrical Technology has 3 warning signs (1 doesn't sit too well with us!) that deserve your attention before going any further with your analysis.

This note has only looked at a single factor that sheds light on the nature of Zhejiang Hongchang Electrical Technology's profit. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.