Investors were disappointed by EnviTec Biogas AG's (ETR:ETG ) latest earnings release. We did some further digging and think they have a few more reasons to be concerned beyond the statutory profit.

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Examining Cashflow Against EnviTec Biogas' 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). 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. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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.

EnviTec Biogas has an accrual ratio of 0.40 for the year to December 2024. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of €65m, in contrast to the aforementioned profit of €28.6m. We saw that FCF was €28m a year ago though, so EnviTec Biogas has at least been able to generate positive FCF in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of EnviTec Biogas.

Our Take On EnviTec Biogas' Profit Performance

As we have made quite clear, we're a bit worried that EnviTec Biogas didn't back up the last year's profit with free cashflow. For this reason, we think that EnviTec Biogas' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. So while earnings quality is important, it's equally important to consider the risks facing EnviTec Biogas at this point in time. Every company has risks, and we've spotted 4 warning signs for EnviTec Biogas (of which 2 are a bit unpleasant!) you should know about.