Zhejiang Zomax Transmission Co., Ltd.'s (SHSE:603767) recent soft profit numbers didn't appear to worry shareholders, as the stock price showed strength. However, we think the company is showing some signs that things are more promising than they seem.

Examining Cashflow Against Zhejiang Zomax Transmission's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 September 2024, Zhejiang Zomax Transmission recorded an accrual ratio of -0.10. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. In fact, it had free cash flow of CN¥162m in the last year, which was a lot more than its statutory profit of CN¥56.8m. Zhejiang Zomax Transmission's free cash flow improved over the last year, which is generally good to see.

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

Our Take On Zhejiang Zomax Transmission's Profit Performance

As we discussed above, Zhejiang Zomax Transmission has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Zhejiang Zomax Transmission's statutory profit actually understates its earnings potential! And we are pleased to note that EPS is at least heading in the right direction over the last three years. 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 want to do dive deeper into Zhejiang Zomax Transmission, you'd also look into what risks it is currently facing. In terms of investment risks, we've identified 1 warning sign with Zhejiang Zomax Transmission, and understanding it should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of Zhejiang Zomax Transmission'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. 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.