What are Capital Requirements?
No matter what, it will always cost a decent amount of money to start a brokerage. In this situation, capital requirements refer to the amount of money needed by your brokerage to fund daily expenses and upcoming projects. These requirements can be anything from start-up costs to paying employee salaries. Every brokerage will need capital in order to start or finance it during the formative years with reasonable estimations considered.
If you’re estimating a lower capital requirement, it’s likely your brokerage will experience difficulties with success. Therefore, it’s better to overestimate and pay back the credits or loans as needed. Generally, for brokerages you’ll automatically want to aim higher in order to gain the right funding for starting your business and guaranteeing a better success rate. That’s why it’s essential for anyone looking to start their own brokerage that they understand how capital works and best practices for budgeting your business.
Also read: NMLS Requirements for Mortgage Brokers
Different Types of Capital Requirements
In business, there are several different types of ‘capital’ that might be used to describe what your brokerage needs. We’ve detailed each of these types below and how best to understand the differences between each one.
Total Capital refers to the funds invested into your brokerage by both owners and debtors; in other terms, this is your total equity combined with total debts. These funds are used to generate income for the business through any current or future operations and allow for the implementation of larger projects – such as a new facility or product line. Examples of this can include money in a bank account, a loan to purchase new production equipment or if you decide to sell later, it’s the cash received from selling ownership of the business.
Available Capital is very straightforward, and simple to understand. It refers to the amount of cash that the company has on hand at a specific point in time.
Working Capital is the difference between your current assets, including cash or any items that can be converted to cash and your liabilities, which can include current bills needing payment. In simpler terms, it refers to the cash available that can cover regular expenses so you don’t have to worry about it regularly.
Long-term capital refers to the sources of funds that do not need to be repaid within the next year. In general, it would include funds received from the sale of ownership, equity and any long-term debt. This specific type is something you most likely won’t have to worry about until later on, if at all.
Calculating Capital Requirements
Before beginning the calculation process, the first step is to set up a business plan or model for your brokerage. You should include financial calculations that show expected revenue from borrowers, expenses that will help your brokerage succeed and any specific capital projects.
Capital projects can be thought of as larger projects that usually benefit the company for many years — such as investing in different CRMs, enlisting in a lead generation tool or hiring an online marketing service.
Once the information and expectations have been finalized, you should then note the differences.Those differences specifically refer to the capital your business needs to secure through investors, debt financing, increases in cash inflows and reductions in cash outflows.
With all of the information, you should be able to figure out your overall capital needed to begin funding your brokerage. The total is figured out by adding up your recurring expenses with any extra costs that might not normally be considered, such as annual payments or unexpected maintenance needs.
It’s important to not plan conservatively regarding this aspect of your brokerage — you want to be prepared for anything unexpected and understand how this process works to create an effective financial plan that will benefit the future of your business.
Check out NMLS Licensing requirements for your state here.
Why is Capital Important?
Now that we’ve learned a little more about capital requirements and how to calculate them, you’re probably wondering why is this so important? Well to start a brokerage and keep it running smoothly, you’ll need to have money available to help pay your expenses and launch the business altogether. It’s important to be able to pay for certain systems you’ll need, salaries to bring on more processors, underwriters and loan officers, rent and various other expenses tied to starting a brokerage.
In addition, these funds may be needed to finance extra virtual assistants, longer-term projects or even lead generation tools that could benefit the expansion and growth of your business later on. It could also help improve your overall ability to increase productivity and bring in more loans month after month.
In some cases, newer brokerages have trouble staying afloat past two years of operation due to poor financial planning in the beginning. Try making a checklist of everything you know you will need to get your brokerage off of its feet and ensure a long, successful life.
What Are Liquid Assets?
The liquid assets of your brokerage can be referred to anything that’s easily converted into cash. Additionally, these assets are readily available and can be directly converted without losing any of its value in the process.
Examples of what a businesses’ liquid assets could include are:
- Accounts Receivable – any money owed to your business
- Cash – on hand or in your business checking accounts
- Demand Deposit – a type of investment
- Inventory – anything that can be expected to sell within one year
- Prepaid Insurance – anything where you’d get your money back if you cancel
- Investments that Mature in 90 Days – such as stocks, U.S. treasuries, bonds, mutual funds or money-market funds
In simplest terms, liquid assets are considered anything of financial value to your brokerage. It’s important for any business to have liquid assets in case of emergencies — such as losing a major borrower or not having enough cash flow to pay your bills on time. Liquid assets are often viewed as cash, and likewise may be called cash equivalents because as a mortgage brokerage owner, you should be confident the assets can easily be exchanged for cash at any time.
Generally, there are several factors that must exist for a liquid asset to be considered liquid. It must be in an established liquid market with a large number of readily available buyers — such as stocks, bonds or forex trading. The most liquid assets are cash and securities that can easily be transacted. Many brokerages can look to assets with a cash conversion of one year or less, but overall this will vary.
All assets, including liquid, are normally found on your brokerages’ balance sheet, which serves as a financial report where you can generate from an accounting software or professional.
Why Are Liquid Assets Important?
Whether you’re opening a small or large brokerage, it’s important to understand liquid assets and how to best utilize them. They’re essential to manage for both internal team performance and understand external reporting. Brokerages with more liquid assets are seen as good and more reliable toward potential creditors (banks) and investors as they’re a better fit to pay back loans.
Businesses with more liquid assets are better equipped to handle uncontrollable problems, such as natural disasters or economic failures. Your brokerage should have enough financial stability within your assets to last at least a month or two if an issue were to arise.
It’s also highly recommended to keep an eye on your liquidity. If it’s very high, it may be the time to invest back into your company in order for it to continue to grow and do whatever you can to improve your business. On the other hand, if your liquidity is too low, your business could be in trouble. If you liquidate some of your assets in advance, it will help improve liquid assets and prepare for any future financial stress.
In most states, it is required businesses have some sort of liquid assets in order to get their licenses — especially as an independent mortgage broker.
Overall, understanding capital requirements and liquid assets is essential toward the success of your new brokerage. If you’re not generating money nor have anything available to you that can help, ultimately your business will suffer immensely.
Try consulting with an accountant when you’re going through this process and you’re guaranteed to create a successful financial plan for your brokerage.