Is Cummins India (NSE:CUMMINSIND) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Cummins India Limited (NSE:CUMMINSIND) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Cummins India

What Is Cummins India's Debt?

The image below, which you can click on for greater detail, shows that at September 2022 Cummins India had debt of ₹2.44b, up from ₹283.5m in one year. However, it does have ₹20.5b in cash offsetting this, leading to net cash of ₹18.0b.

How Healthy Is Cummins India's Balance Sheet?

We can see from the most recent balance sheet that Cummins India had liabilities of ₹17.5b falling due within a year, and liabilities of ₹2.79b due beyond that. Offsetting this, it had ₹20.5b in cash and ₹14.2b in receivables that were due within 12 months. So it can boast ₹14.4b more liquid assets than total liabilities.

This surplus suggests that Cummins India has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Cummins India boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Cummins India grew its EBIT by 19% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Cummins India can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. Over the most recent three years, Cummins India recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Cummins India has ₹18.0b in net cash and a decent-looking balance sheet. And we liked the look of last year's 19% year-on-year EBIT growth. So is Cummins India's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Cummins India is showing 1 warning sign in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.