Shareholders appeared unconcerned with Tian Yuan Group Holdings Limited's (HKG:6119) lackluster earnings report last week. Our analysis suggests that while the profits are soft, the foundations of the business are strong.

View our latest analysis for Tian Yuan Group Holdings

Examining Cashflow Against Tian Yuan Group Holdings' Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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".

Over the twelve months to December 2021, Tian Yuan Group Holdings recorded an accrual ratio of -0.56. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of CN¥175m, well over the CN¥12.7m it reported in profit. Notably, Tian Yuan Group Holdings had negative free cash flow last year, so the CN¥175m it produced this year was a welcome improvement.

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

Our Take On Tian Yuan Group Holdings' Profit Performance

Happily for shareholders, Tian Yuan Group Holdings produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Tian Yuan Group Holdings' statutory profit actually understates its earnings potential! Better yet, its EPS are growing strongly, which is nice to see. 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. So while earnings quality is important, it's equally important to consider the risks facing Tian Yuan Group Holdings at this point in time. For example - Tian Yuan Group Holdings has 3 warning signs we think you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of Tian Yuan Group Holdings' 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. 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.