Capitalization or Leverage

In any financial institutions, a capital is of importance in order to begin and sustain the life of the business. The money involved in the process should be revolving while gaining profit to remain in the operation. It is important that the insurance company should have enough funds to provide for the expenses that might be needed during a claim.

Capitalization should be a basic component of these financial institutions. Capitalization or leverage is the sum of the long –term, retained earnings and stocks of a corporation or a company. In the retail industry, the calculation is based on the market price of the company multiplied by the number of shares by the price per share.

In the insurance industry, health insurers need to have adequate strong capital bases, adequate loss reserves and an ongoing ability to produce enough earnings to build and protect overall capitalization. The big risks to capital loss can come from different areas of a casualty/ property insurer’s operating environment which will include off balance sheet liabilities, insurance liabilities, financial risks and general business risk and other invested and asset quality. These possible risks must be balanced with the insurer’s available resources for him to be able to pay for the insured’s claims. This considers and identifies the risks and sources of casualty/ property insurer’s capitalization to measure the right amounts of capital to support these businesses at different levels of financial strength. Part of this evaluation is its quantitative and qualitative measure.

On the other hand, leveraging is an act of borrowing financial resources and this borrowing can take on several forms. One means of borrowing that is most common nowadays is obtaining a loan to provide additional cash source. Another way is by purchasing a debt such as obtaining the mortgage of a competitor, this will increase the degree of leverage in the business industry. Another form of leverage is trading investments on the margin extended to an investor by payment to a broker firm.

There are several factors that is required to achieve a desired outcome on the degree of financial leverage. First, the amount of loan and the assets in hand have relatively a close relation that is needed to be successfully carried out on the deal. This is of both important to put equilibrium between the two important elements- the assets and the loan because this might put the company in a severe financial hardships if the deal does not go along the way it is planned.

Aside from maintaining a favorable equilibrium between the two elements, it is also important that the degree of financial leverage inherent in the proposal deal to be measure. For you to understand the financial leverage to its degree, project the percentage change in the amount of earning lost or gained on each unit or share involved with the deal. Before any applicable taxes or interests are added or accounted on the leverage, calculate the degree as soon as possible.