Sumitomo Chemical India (NSE:SUMICHEM) Seems To Use Debt Rather Sparingly

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.' 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. Importantly, Sumitomo Chemical India Limited (NSE:SUMICHEM) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Sumitomo Chemical India

What Is Sumitomo Chemical India's Debt?

You can click the graphic below for the historical numbers, but it shows that Sumitomo Chemical India had ₹316.5m of debt in September 2022, down from ₹429.0m, one year before. However, it does have ₹7.25b in cash offsetting this, leading to net cash of ₹6.93b.

How Healthy Is Sumitomo Chemical India's Balance Sheet?

The latest balance sheet data shows that Sumitomo Chemical India had liabilities of ₹11.9b due within a year, and liabilities of ₹416.1m falling due after that. On the other hand, it had cash of ₹7.25b and ₹11.9b worth of receivables due within a year. So it actually has ₹6.75b more liquid assets than total liabilities.

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

Also positive, Sumitomo Chemical India grew its EBIT by 25% in the last year, and that should make it easier to pay down debt, going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Sumitomo Chemical India's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. In the last three years, Sumitomo Chemical India's free cash flow amounted to 42% 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 Sumitomo Chemical India has ₹6.93b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 25% over the last year. So we don't think Sumitomo Chemical India's use of debt is risky. 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.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.