What Is Equity?
Equity is the owners' residual claim on a business — what's left of the assets after all liabilities are paid. On the balance sheet it equals total assets minus total liabilities, and it represents the net worth belonging to the owners or shareholders.
What equity is and why it matters
Equity is the third element of the accounting equation (assets = liabilities + equity). It's built from what owners put in (contributed capital) plus the profits the business has retained rather than distributed (retained earnings), less any withdrawals or dividends. Equity measures the true value owners hold in the business and how much is financed by ownership versus debt. Growing equity over time — through retained profits — is a sign of a healthy, self-funding business; shrinking equity can signal losses or heavy distributions.
A worked example
A company has total assets of $800,000 and total liabilities of $500,000, so equity is $300,000. During the year it earns $120,000 in net income and pays $40,000 in dividends. Retained earnings rise by $80,000, lifting equity to $380,000 (assuming no new capital or withdrawals). The equation stays intact: if assets grow to $880,000 and liabilities hold at $500,000, equity is indeed $380,000.
How firms handle it today
Firms track equity accounts — contributed capital, retained earnings, distributions — in the general ledger and reconcile them at close so the balance sheet reflects accurate owner net worth.
Related terms
- Shareholder equity
- Retained earnings
- Balance sheet
- Capital
- Asset
FAQ
How is equity calculated?
Total assets minus total liabilities. It's the owners' residual claim on the business.
What makes up equity?
Contributed capital (owner/investor money in) plus retained earnings, less distributions or treasury stock.
What's the difference between equity and capital?
Capital is money put into the business; equity is the broader owners' claim, including retained profits.