Abstract Background Children’s stool disposal is often overlooked in sanitation programs of any country. Unsafe disposal of children’s stool makes children susceptible to many diseases that transmit through faecal-oral route. Therefore, the study aims to examine the magnitude of unsafe disposal of children’s stools in India, the factors associated with it and finally its association with childhood diarrhea. Methods Data from the third round of the National Family Health Survey (NFHS-3) conducted in 2005–06 is used to carry out the analysis. The binary logistic regression model is used to examine the factors associated with unsafe disposal of children’s stool. Binary logistic regression is also used to examine the association between unsafe disposal of children’s stool and childhood diarrhea. Result Overall, stools of 79% of children in India were disposed of unsafely. The urban-rural gap in the unsafe disposal of children’s stool was wide. Mother’s illiteracy and lack of exposure to media, the age of the child, religion and caste/tribe of the household head, wealth index, access to toilet facility and urban-rural residence were statistically associated with unsafe disposal of stool. The odds of diarrhea in children whose stools were disposed of unsafely was estimated to be 11% higher (95% CI: 1.01–1.21) than that of children whose stools were disposed of safely. An increase in the unsafe disposal of children’s stool in the community also increased the risk of diarrhea in children. Conclusion We found significant statistical association between children’s stool disposal and diarrhea. Therefore, gains in reduction of childhood diarrhea can be achieved in India through the complete elimination of unsafe disposal of children’s stools. The sanitation programmes currently being run in India must also focus on safe disposal of children’s stool.