Anhui Huilong Agricultural Means of Production Co.,Ltd.'s (SZSE:002556) stock performed strongly after the recent earnings report. However, we think that investors should be cautious when interpreting the profit numbers.

Zooming In On Anhui Huilong Agricultural Means of ProductionLtd'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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. 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 September 2024, Anhui Huilong Agricultural Means of ProductionLtd recorded an accrual ratio of 0.20. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of CN¥127.8m, a look at free cash flow indicates it actually burnt through CN¥1.0b in the last year. We also note that Anhui Huilong Agricultural Means of ProductionLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥1.0b. 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 Anhui Huilong Agricultural Means of ProductionLtd.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by CN¥38m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. Anhui Huilong Agricultural Means of ProductionLtd had a rather significant contribution from unusual items relative to its profit to September 2024. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Anhui Huilong Agricultural Means of ProductionLtd's Profit Performance

Summing up, Anhui Huilong Agricultural Means of ProductionLtd received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Anhui Huilong Agricultural Means of ProductionLtd's profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Anhui Huilong Agricultural Means of ProductionLtd as a business, it's important to be aware of any risks it's facing. At Simply Wall St, we found 4 warning signs for Anhui Huilong Agricultural Means of ProductionLtd and we think they deserve your attention.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. 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.