Sumitomo Chemical India (NSE:SUMICHEM) 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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Sumitomo Chemical India Limited (NSE:SUMICHEM) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Sumitomo Chemical India

What Is Sumitomo Chemical India's Net Debt?

The image below, which you can click on for greater detail, shows that Sumitomo Chemical India had debt of ₹302.5m at the end of March 2024, a reduction from ₹339.7m over a year. However, its balance sheet shows it holds ₹10.3b in cash, so it actually has ₹9.97b net cash.

A Look At Sumitomo Chemical India's Liabilities

The latest balance sheet data shows that Sumitomo Chemical India had liabilities of ₹8.01b due within a year, and liabilities of ₹680.2m falling due after that. On the other hand, it had cash of ₹10.3b and ₹9.38b worth of receivables due within a year. So it actually has ₹11.0b more liquid assets than total liabilities.

This short term liquidity is a sign that Sumitomo Chemical India could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Sumitomo Chemical India boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Sumitomo Chemical India saw its EBIT drop by 2.8% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Sumitomo Chemical India can strengthen its balance sheet over time. 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. Sumitomo Chemical 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, Sumitomo Chemical India recorded free cash flow worth 77% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Sumitomo Chemical India has ₹9.97b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 77% of that EBIT to free cash flow, bringing in ₹6.9b. So is Sumitomo Chemical India's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Sumitomo Chemical India's earnings per share history for free.

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.