Quality of Earnings Explained: 2025 Guide for Australian Investors

Quality of earnings is a financial buzzword that’s more than just another metric. In the current economic climate, with volatile markets and new accounting rules rolling out in 2025, understanding the quality behind a company’s earnings can be the difference between smart investment decisions and costly missteps. Here’s what you need to know to cut through the noise and find the real story behind the numbers.

What Is Quality of Earnings? (And Why the Headlines Don’t Tell All)

On paper, a company’s earnings might look impressive — but headline profits alone rarely paint the full picture. Quality of earnings refers to how much of a company’s income is sustainable, repeatable, and genuinely reflects its core business operations, as opposed to being inflated by one-off events, aggressive accounting, or temporary boosts.

For example, in 2025, Australian companies face new disclosure requirements under updated AASB standards, pushing for greater transparency around non-recurring items and fair value adjustments. Investors need to be more vigilant than ever, as businesses adapt to these changes in how they report their results.

• High-quality earnings come from regular, ongoing business activities (e.g., sales revenue, recurring service fees).

• Low-quality earnings might be propped up by asset sales, government grants, or changes in accounting policy.

Why does this matter? If a company’s profits are built on shaky ground, its share price, dividends, and even survival can be at risk when those short-term boosts disappear.

How to Assess Quality of Earnings in 2025

With the Australian Securities and Investments Commission (ASIC) flagging a renewed focus on earnings manipulation and misleading disclosures, investors and business owners need to dig deeper than ever. Here’s how you can get started:

Analyse Revenue Sources

Break down where the money is coming from. Is it sustainable, or is there a sudden spike from a one-off transaction? For example, a mining company might report a surge in profits after selling off a piece of land — but that’s not a recurring event.

Watch for Accounting Changes

In 2025, updates to AASB 1060 mean more detailed segment reporting and tighter rules on what counts as ‘core’ earnings. Companies might shift certain items ‘below the line’ to make profits look cleaner. Check the notes to the accounts for any changes in revenue recognition or expense timing.

Scrutinise Cash Flow

Strong profits should be backed by strong cash flow. If reported earnings are rising but operating cash flow is flat or negative, that’s a red flag. In the wake of the 2024–25 economic slowdown, this mismatch has tripped up several mid-cap ASX firms.

Non-Recurring Items

Look out for significant gains from asset sales, insurance payouts, or government incentives (like the now-winding-down instant asset write-off). Are these items being included in ‘underlying’ or ‘normalised’ earnings?

Tip: Compare a company’s reported earnings (statutory profit) to its ‘underlying’ or ‘normalised’ earnings. If there’s a large gap, dig into the details to understand why.

Real-World Examples: Quality of Earnings in Action

In early 2025, several high-profile ASX companies faced scrutiny after reporting strong headline profits, only for analysts to uncover that much of the growth came from non-core activities. For instance:

• Retailers benefited from short-term government stimulus in 2024, but as those payments tapered off in 2025, underlying sales growth slowed dramatically.

• Tech firms capitalised on the R&D Tax Incentive, recognising large credits as income, but these incentives are being scaled back under the 2025–26 Budget.

• Energy companies reported bumper profits from asset revaluations due to surging commodity prices, but core operating earnings were flat.

Investors who looked beyond the headline numbers were able to avoid share price shocks when the market recalibrated to the true, lower level of sustainable earnings.

Red Flags and Practical Questions for Investors

Whether you’re investing in shares, buying a business, or reviewing your own company’s performance, here are some warning signs that the quality of earnings may be low:

• Significant difference between cash flow and reported profit

• Frequent changes in accounting policies or segment reporting

• Heavy reliance on non-recurring income or government incentives

• Large ‘adjustments’ between statutory and underlying earnings

• Unexplained or poorly disclosed related-party transactions

Ask: “How much of these earnings can we expect again next year, and what could cause them to fall away?”

The Bottom Line: Quality Beats Quantity

In 2025’s fast-changing regulatory and economic environment, understanding the quality of earnings is crucial for anyone who cares about long-term value. With new accounting rules, greater scrutiny from ASIC, and more volatile market conditions, relying on headline profits alone is riskier than ever.

Whether you’re an investor, business owner, or adviser, make quality of earnings a core part of your analysis. Dig deeper, ask questions, and demand transparency — your returns and peace of mind will thank you.