The market wasn't impressed with the soft earnings from Cubic Sensor and Instrument Co.,Ltd. (SHSE:688665) recently. We did some analysis, and found that there are some reasons to be cautious about the headline numbers.

A Closer Look At Cubic Sensor and InstrumentLtd'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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.

Cubic Sensor and InstrumentLtd has an accrual ratio of 0.27 for the year to December 2023. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥39m despite its profit of CN¥132.7m, mentioned above. We also note that Cubic Sensor and InstrumentLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥39m.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Cubic Sensor and InstrumentLtd's Profit Performance

Cubic Sensor and InstrumentLtd's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Cubic Sensor and InstrumentLtd's true underlying earnings power is actually less than its statutory profit. But at least holders can take some solace from the 18% per annum growth in EPS for the last three. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Be aware that Cubic Sensor and InstrumentLtd is showing 2 warning signs in our investment analysis and 1 of those can't be ignored...

This note has only looked at a single factor that sheds light on the nature of Cubic Sensor and InstrumentLtd'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 that insiders are buying.

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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.