The latest earnings report from Good Times Restaurants Inc. (NASDAQ:GTIM) was disappointing for shareholders. However, our analysis suggests that the weak headline numbers are offset by some positive underlying factors.

Check out our latest analysis for Good Times Restaurants

Looking at cash flow versus earnings at Good Times Restaurants

In high finance, the most important metric that measures how well a company converts reported earnings into free cash flow (FCF) is the Delimitation ratio (from cash flow). Simply put, this ratio subtracts FCF from net income and divides that number by the company’s average funds from operations during that period. The ratio tells us how much a company’s profit exceeds its FCF.

Therefore, it is actually considered good if a company has a negative accrual ratio, but bad if its accrual ratio is positive. While an accrual ratio above zero is hardly a cause for concern, we think it is worth noting if a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, “Companies with higher accruals tend to be less profitable in the future.”

For the twelve months to June 2024, Good Times Restaurants recorded an accrual ratio of -0.10. This means its free cash flow was quite a bit higher than its statutory profit. That is, it generated free cash flow of US$4.1m in that period, dwarfing its reported profit of US$1.13m. Good Times Restaurants’ free cash flow has improved over the last year, which is generally pleasing. However, a recent tax benefit and some unusual items appear to have impacted profit (and hence the accrual ratio).

Note: We always recommend investors check balance sheet strength. Click here to access our balance sheet analysis of Good Times Restaurants.

The impact of unusual items on profit

Good Times Restaurants’ earnings were reduced by US$418k worth of unusual items over the last twelve months, which contributed to high cash conversion reflected in the unusual items. In a scenario where these unusual items included non-cash costs, we’d expect to see a strong accrual ratio, and that’s exactly what happened in this case. It’s never nice when unusual items cost the company profit, but the bright side is that things could improve sooner rather than later. When we analyzed the vast majority of publicly traded companies worldwide, we found that significant unusual items are often not repeated. And that’s exactly what accounting terminology implies. Therefore, assuming these unusual expenses don’t recur, we’d expect Good Times Restaurants to generate higher profits next year, all else remaining unchanged.

An unusual tax situation

In addition to the remarkable accrual ratio, we can see that Good Times Restaurants received a tax benefit of $482,000. It is always a little remarkable when a company is paid by the IRS instead of paying the IRS. Of course at first glance It’s great to get a tax benefit. However, the devil is in the details: such benefits only have an impact in the year they are booked and are often one-off in nature. In the likely event that the tax benefit is not repeated, we would expect statutory profit levels to fall, at least in the absence of strong growth.

Our assessment of the earnings development of Good Times Restaurants

In summary, Good Times Restaurants’ accrual ratio and unusual items suggest that its statutory profits have temporarily declined, while its tax benefits have had the opposite effect. Taking all these factors into account, we’d say that Good Times Restaurants’ underlying earnings power is at least as good as its statutory numbers suggest. With that in mind, it’s important to learn about the risks involved if you want to conduct further analysis of the company. You’ll be interested to know that we found 3 warning signs for Good Times Restaurants and you want to know more about it.

Our research into Good Times Restaurants focused on certain factors that can make earnings look better than they are. And the company passed the test with flying colors. But there are many other ways to form an opinion about a company. Some people consider a high return on equity to be a good sign of a high-quality company, so you might want to look at free Collection of companies with high return on equity or this list of stocks with high insider ownership.

Do you have feedback on this article? Are you concerned about the content? Contact us directly from us. Alternatively, send an email to editorial-team (at) simplywallst.com.

This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.