Investors Can Find Comfort In Wonlim's (KRX:005820) Earnings Quality

Soft earnings didn't appear to concern Wonlim Corporation's (KRX:005820) shareholders over the last week. We did some digging, and we believe the earnings are stronger than they seem.

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Examining Cashflow Against Wonlim's 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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

Wonlim has an accrual ratio of -0.14 for the year to March 2025. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of ₩19b, well over the ₩2.68b it reported in profit. Wonlim's free cash flow improved over the last year, which is generally good to see. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Check out our latest analysis for Wonlim

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

The Impact Of Unusual Items On Profit

Wonlim's profit was reduced by unusual items worth ₩1.1b 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. 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. If Wonlim doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Wonlim's Profit Performance

In conclusion, both Wonlim's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. After considering all this, we reckon Wonlim's statutory profit probably understates its earnings potential! If you'd like to know more about Wonlim as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 4 warning signs for Wonlim (of which 1 is concerning!) you should know about.

After our examination into the nature of Wonlim's profit, we've come away optimistic for the company. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.