The latest earnings report from Shenzhen Topway Video Communication Co., Ltd (SZSE:002238 ) disappointed investors. We did some digging and think there are some comforting factors lying beneath the statutory profit numbers.

Zooming In On Shenzhen Topway Video Communication'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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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.

For the year to September 2024, Shenzhen Topway Video Communication had an accrual ratio of -0.10. That indicates that its free cash flow was a fair bit more than its statutory profit. Indeed, in the last twelve months it reported free cash flow of CN¥221m, well over the CN¥61.1m it reported in profit. Given that Shenzhen Topway Video Communication had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥221m would seem to be a step in the right direction. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

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

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that Shenzhen Topway Video Communication's profit was boosted by unusual items worth CN¥105m in the last twelve months. 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'. Shenzhen Topway Video Communication had a rather significant contribution from unusual items relative to its profit to September 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Shenzhen Topway Video Communication's Profit Performance

Shenzhen Topway Video Communication's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Based on these factors, we think it's very unlikely that Shenzhen Topway Video Communication's statutory profits make it seem much weaker than it is. So while earnings quality is important, it's equally important to consider the risks facing Shenzhen Topway Video Communication at this point in time. To help with this, we've discovered 4 warning signs (1 is concerning!) that you ought to be aware of before buying any shares in Shenzhen Topway Video Communication.

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 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 with significant insider holdings 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.