The market for Qilian International Holding Group Limited's (NASDAQ:QLI) shares didn't move much after it posted weak earnings recently. We did some digging, and we believe the earnings are stronger than they seem.

See our latest analysis for Qilian International Holding Group

Zooming In On Qilian International Holding Group'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. 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. 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 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.

For the year to September 2022, Qilian International Holding Group had an accrual ratio of -0.17. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of US$9.4m during the period, dwarfing its reported profit of US$1.08m. Given that Qilian International Holding Group had negative free cash flow in the prior corresponding period, the trailing twelve month resul of US$9.4m 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 Qilian International Holding Group.

How Do Unusual Items Influence Profit?

Qilian International Holding Group's profit was reduced by unusual items worth US$813k in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. If Qilian International Holding Group doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Qilian International Holding Group's Profit Performance

Considering both Qilian International Holding Group's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. Based on these factors, we think Qilian International Holding Group's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! If you'd like to know more about Qilian International Holding Group as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 5 warning signs for Qilian International Holding Group you should be mindful of and 2 of them don't sit too well with us.

After our examination into the nature of Qilian International Holding Group's profit, we've come away optimistic for the company. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.