Shareholders didn't seem to be thrilled with Tandy Leather Factory, Inc.'s (NASDAQ:TLF) recent earnings report, despite healthy profit numbers. Our analysis has found some concerning factors which weaken the profit's foundation.

A Closer Look At Tandy Leather Factory's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to September 2025, Tandy Leather Factory had an accrual ratio of 0.42. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of US$10.4m, a look at free cash flow indicates it actually burnt through US$8.3m in the last year. We saw that FCF was US$813k a year ago though, so Tandy Leather Factory has at least been able to generate positive FCF in the past. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by US$16m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. Which is hardly surprising, given the name. We can see that Tandy Leather Factory's positive unusual items were quite significant relative to its profit in the year to September 2025. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Tandy Leather Factory's Profit Performance

Tandy Leather Factory had a weak accrual ratio, but its profit did receive a boost from unusual items. For all the reasons mentioned above, we think that, at a glance, Tandy Leather Factory's statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. So while earnings quality is important, it's equally important to consider the risks facing Tandy Leather Factory at this point in time. For example, we've found that Tandy Leather Factory has 2 warning signs (1 is potentially serious!) that deserve your attention before going any further with your analysis.

Our examination of Tandy Leather Factory has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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.

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.