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Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether CyberArk Software's (NASDAQ:CYBR) statutory profits are a good guide to its underlying earnings.

While CyberArk Software was able to generate revenue of US$449.6m in the last twelve months, we think its profit result of US$2.92m was more important. As you can see in the chart below, its profit has declined over the last three years, even though its revenue has increased.

View our latest analysis for CyberArk Software

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll look at what CyberArk Software's cashflow tells us about the quality of its earnings. 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.

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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.

Over the twelve months to September 2020, CyberArk Software recorded an accrual ratio of -0.64. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of US$114m during the period, dwarfing its reported profit of US$2.92m. CyberArk Software's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons.

As we discussed above, CyberArk Software'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 CyberArk Software's statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you want to do dive deeper into CyberArk Software, you'd also look into what risks it is currently facing. For example, we've found that CyberArk Software has 5 warning signs (1 doesn't sit too well with us!) that deserve your attention before going any further with your analysis.

Today we've zoomed in on a single data point to better understand the nature of CyberArk Software's profit. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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This article by Simply Wall St is general in nature. 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. *Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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Here's Why We Think CyberArk Software's (NASDAQ:CYBR) Statutory Earnings Might Be Conservative - Simply Wall St