We Think Cummins India (NSE:CUMMINSIND) Can Manage Its Debt With Ease

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 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 assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Cummins India

What Is Cummins India's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Cummins India had ₹3.95b of debt, an increase on ₹202.2m, over one year. However, it does have ₹20.0b in cash offsetting this, leading to net cash of ₹16.1b.

How Strong Is Cummins India's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Cummins India had liabilities of ₹17.4b due within 12 months and liabilities of ₹2.22b due beyond that. On the other hand, it had cash of ₹20.0b and ₹12.6b worth of receivables due within a year. So it actually has ₹13.0b 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. Succinctly put, Cummins India boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Cummins India has boosted its EBIT by 51%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Cummins India will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Cummins India has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Cummins India produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Cummins India has net cash of ₹16.1b, as well as more liquid assets than liabilities. And we liked the look of last year's 51% year-on-year EBIT growth. So we don't think Cummins India's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Cummins India you should know about.

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.