The stock was sluggish on the back of Kidztech Holdings Limited's (HKG:6918) recent earnings report. Along with the solid headline numbers, we think that investors have some reasons for optimism.

See our latest analysis for Kidztech Holdings

Examining Cashflow Against Kidztech Holdings' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 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".

For the year to December 2021, Kidztech Holdings had an accrual ratio of -0.35. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of CN¥156m during the period, dwarfing its reported profit of CN¥26.1m. Given that Kidztech Holdings had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥156m would seem to be a step in the right direction.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Kidztech Holdings.

Our Take On Kidztech Holdings' Profit Performance

Happily for shareholders, Kidztech Holdings produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Kidztech Holdings' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! 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 Kidztech Holdings, you'd also look into what risks it is currently facing. For example, Kidztech Holdings has 3 warning signs (and 1 which is potentially serious) we think you should know about.

This note has only looked at a single factor that sheds light on the nature of Kidztech Holdings' 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. 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 that insiders are buying 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.