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The most recent earnings report from Arcontech Group plc (LON:ARC) was disappointing for shareholders. Despite the soft profit numbers, our analysis has optimistic about the overall quality of the income statement.
View our latest analysis for Arcontech Group
Examining Cashflow Against Arcontech Group's 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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.
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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
Arcontech Group has an accrual ratio of -0.45 for the year to December 2024. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of UK£1.7m during the period, dwarfing its reported profit of UK£1.05m. Arcontech Group shareholders are no doubt pleased that free cash flow improved over the last twelve months.
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 Arcontech Group's Profit Performance
As we discussed above, Arcontech Group's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Arcontech Group's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at 7.7% per year over the last three years. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. So while earnings quality is important, it's equally important to consider the risks facing Arcontech Group at this point in time. Every company has risks, and we've spotted 3 warning signs for Arcontech Group (of which 1 is a bit unpleasant!) you should know about.