Shareholders appeared unconcerned with Yinchuan Xinhua Commercial (Group) Co., Ltd.'s (SHSE:600785) lackluster earnings report last week. Our analysis suggests that while the profits are soft, the foundations of the business are strong.

A Closer Look At Yinchuan Xinhua Commercial (Group)'s Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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.

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. 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 2024, Yinchuan Xinhua Commercial (Group) had an accrual ratio of -0.12. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of CN¥416m during the period, dwarfing its reported profit of CN¥106.8m. Yinchuan Xinhua Commercial (Group)'s 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. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

The Impact Of Unusual Items On Profit

Surprisingly, given Yinchuan Xinhua Commercial (Group)'s accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥20m in unusual items. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. 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. And that's as you'd expect, given these boosts are described as 'unusual'. 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 Yinchuan Xinhua Commercial (Group)'s Profit Performance

In conclusion, Yinchuan Xinhua Commercial (Group)'s accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. After taking into account all these factors, we think that Yinchuan Xinhua Commercial (Group)'s statutory results are a decent reflection of its underlying earnings power. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Every company has risks, and we've spotted 2 warning signs for Yinchuan Xinhua Commercial (Group) you should know about.

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 with significant insider holdings to be useful.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.