The market seemed underwhelmed by last week's earnings announcement from Where Food Comes From, Inc. (NASDAQ:WFCF) despite the healthy numbers. Our analysis suggests that shareholders might be missing some positive underlying factors in the earnings report.

See our latest analysis for Where Food Comes From

Examining Cashflow Against Where Food Comes From's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2024, Where Food Comes From recorded an accrual ratio of -0.13. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. To wit, it produced free cash flow of US$2.8m during the period, dwarfing its reported profit of US$1.94m. Where Food Comes From's free cash flow improved over the last year, which is generally good to see.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Where Food Comes From.

Our Take On Where Food Comes From's Profit Performance

As we discussed above, Where Food Comes From has perfectly satisfactory free cash flow relative to profit. Because of this, we think Where Food Comes From's earnings potential is at least as good as it seems, and maybe even better! And on top of that, its earnings per share increased by 9.8% in the last year. 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 if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Every company has risks, and we've spotted 1 warning sign for Where Food Comes From you should know about.

Today we've zoomed in on a single data point to better understand the nature of Where Food Comes From's profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.