Gansu Dunhuang Seed Group Co.,Ltd.'s (SHSE:600354) earnings announcement last week was disappointing for investors, despite the decent profit numbers. Our analysis says that investors should be optimistic, as the strong profit is built on solid foundations.

Zooming In On Gansu Dunhuang Seed GroupLtd'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. 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'.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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.

Gansu Dunhuang Seed GroupLtd has an accrual ratio of -0.33 for the year to December 2023. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of CN¥177m in the last year, which was a lot more than its statutory profit of CN¥40.8m. Gansu Dunhuang Seed GroupLtd's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Gansu Dunhuang Seed GroupLtd.

Our Take On Gansu Dunhuang Seed GroupLtd's Profit Performance

As we discussed above, Gansu Dunhuang Seed GroupLtd's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Gansu Dunhuang Seed GroupLtd's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at an extremely impressive rate over the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. While earnings are important, another area to consider is the balance sheet. You can see our latest analysis on Gansu Dunhuang Seed GroupLtd's balance sheet health here.

This note has only looked at a single factor that sheds light on the nature of Gansu Dunhuang Seed GroupLtd's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.