Even though Yabao Pharmaceutical Group Co., Ltd's (SHSE:600351) recent earnings release was robust, the market didn't seem to notice. We think that investors have missed some encouraging factors underlying the profit figures.

Examining Cashflow Against Yabao Pharmaceutical Group'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. 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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Yabao Pharmaceutical Group has an accrual ratio of -0.15 for the year to March 2024. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of CN¥594m, well over the CN¥204.4m it reported in profit. Yabao Pharmaceutical Group shareholders are no doubt pleased that free cash flow improved over the last twelve months. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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

How Do Unusual Items Influence Profit?

Yabao Pharmaceutical Group's profit was reduced by unusual items worth CN¥98m 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. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect Yabao Pharmaceutical Group to produce a higher profit next year, all else being equal.

Our Take On Yabao Pharmaceutical Group's Profit Performance

In conclusion, both Yabao Pharmaceutical Group's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Looking at all these factors, we'd say that Yabao Pharmaceutical Group's underlying earnings power is at least as good as the statutory numbers would make it seem. If you'd like to know more about Yabao Pharmaceutical Group as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 2 warning signs for Yabao Pharmaceutical Group you should know about.

Our examination of Yabao Pharmaceutical Group has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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.