Cummins India (NSE:CUMMINSIND) Could Easily Take On More Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Cummins India Limited (NSE:CUMMINSIND) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Cummins India

How Much Debt Does Cummins India Carry?

You can click the graphic below for the historical numbers, but it shows that Cummins India had ₹283.5m of debt in September 2021, down from ₹4.93b, one year before. But on the other hand it also has ₹14.1b in cash, leading to a ₹13.8b net cash position.

How Healthy Is Cummins India's Balance Sheet?

The latest balance sheet data shows that Cummins India had liabilities of ₹13.3b due within a year, and liabilities of ₹2.08b falling due after that. Offsetting this, it had ₹14.1b in cash and ₹13.8b in receivables that were due within 12 months. So it can boast ₹12.6b more liquid assets than total liabilities.

This short term liquidity is a sign that Cummins India could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Cummins India has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Cummins India has boosted its EBIT by 66%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Cummins India's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Cummins India may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Cummins India's free cash flow amounted to 45% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Cummins India has ₹13.8b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 66% over the last year. So is Cummins India's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Cummins India you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.