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Soft earnings didn't appear to concern Karin Technology Holdings Limited's (SGX:K29) shareholders over the last week. Our analysis suggests that while the profits are soft, the foundations of the business are strong.
See our latest analysis for Karin Technology Holdings
Examining Cashflow Against Karin Technology Holdings' Earnings
Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
Karin Technology Holdings has an accrual ratio of -0.26 for the year to June 2024. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of HK$128m during the period, dwarfing its reported profit of HK$19.0m. Karin Technology Holdings shareholders are no doubt pleased that free cash flow improved over the last twelve months. Having said that, there is more to the story. 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 Karin Technology Holdings.
How Do Unusual Items Influence Profit?
Karin Technology Holdings' profit was reduced by unusual items worth HK$5.8m 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, after all, that's exactly what the accounting terminology implies. If Karin Technology Holdings doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.