Earnings Growth vs. Earnings Quality
By: Ally Whatley
Jan. 7, 2026
Measuring Metrics
Most financial modes rely on earnings growth, management trends, and revenue trends. These metric measurements are useful, but they are missing a key accounting indicator: earnings quality. Multiple companies within the same market can report relative earnings, yet their future performance - and forecast accuracy - can differ substantially based on how those earnings were generated and where they are now.
Looking through an accounting lens, earnings quality typically refers to how substantial and reliable the reporting of income is. When comparing high-quality earnings vs low-quality earnings, it is critical to be able to find key indicators that drive the quality of reported income. High-quality earnings are produced by a company's core operations and are supported by cash flows. Whereas low-quality earnings rely more heavily on accounting estimates, non-recurring adjustments, or timing differences. The differences between high-quality and low-quality earnings matters because from an accounting-earnings perspective, a lack of cash support tends to reverse over time, creating forecast risk.
Low-Quality Drivers
There are numerous drivers that can cause companies to have low earnings quality. A few of these variables include:
● Accrual accounting
● Adjusted earnings
● Revenue recognition timing
● Working capital trends
Accrual accounting is one of the leading drivers of low-quality earnings because accruals allow revenue to be recognized before cash is received and expenses to be deferred through capitalization. While accrual accounting can be useful for improving period matching, excessive use of accruals can artificially inflate earnings in the short term. This causes a disconnect when analyzing a company's earnings for what they are showing currently, versus where they will actually lead to in the future.
Another driver that can cause earnings to suffer is in the growing use of “adjusted” earnings. Adjusted earnings is when a company discludes items such as restricted costs, acquisition-related expenses, or stock-based compensation to portray a more normalized earnings figure. From an accounting standpoint, the issue doesn't lie within the exclusion itself, but the consistency of the exclusions. When supposed non-recurring items appear year after year, adjusting earnings can mislead forward-looking estimates and overstate sustainable profitability. According to the FASB (Financial Accounting Standards Board), the definition for revenue recognition is to recognize and report revenue and expenses when a good or service is earned, and followed by a five step process known as ASC 606.
“Under the Revenue Recognition Principle, revenue must be recorded in the period when the product or service was delivered (i.e. “earned”) – whether or not cash was collected from the
customer.”
This rule allows companies to have significant judgement when estimating transaction prices, performance obligations, and variable considerations. Small changes within these variables can accelerate or delay revenue recognition, which affects reported earnings without changes to cash flows. Forecasts models that assume reported revenue will persist at the same rate may underestimate the risk of future earnings reversals.
Another accounting-based signal often ignored in forecasts is working capital trends. Rapid revenue growth along with rising accounts receivable or inventory can indicate that earnings are not converting into cash. While net income may appear strong, deteriorating working capital can pressure future margins and cash flows, which can cause earnings to fluctuate substantially.
Why It Matters
Including earnings quality over earnings growth into forecast analysis does not require intricate modeling. Simple accounting relationships and consistent accounting policies can make all the difference in creating high-quality earnings for companies.
Ultimately, earnings growth tells us what was reported, but earnings quality helps predict what will last. Understanding the accounting behind the numbers shown in analysis and forecasts is now the difference for accessing credibility and projecting performance.
