Many companies make the decision to carry a material amount of cash on their balance sheet. Corporations inherently need some level of cash to operate their business, without which they would have liquidity issues and customers and suppliers would be hesitant to build long-term relationships with them. However, companies with substantial cash balances (above what one might view as “operating” cash) can see as-reported ROA diluted because of the substantial portion of the balance sheet that ends up being taken up by cash that is earning limited or no return, especially in the current environment. As such, if excess cash is not removed from the asset base of a company before looking at performance metrics, a company can appear to have substantially lower operating profitability (in terms of ROA) than it actually has.
When a company carries a material excess cash balance, as-reported metrics like ROA materially understate the company’s true profitability and capital efficiency versus UAFRS-based metrics. This can lead to investors and management believing that the company has weaker performance than is justified, depressing valuations.