Equity is the ownership stake in a business - what's left after you subtract all liabilities from your assets. It represents what the business is actually worth to its owners.
Equity is the headline number for how much your business is actually worth to you. For a sole trader or small business owner, it's the answer to "If I sold the business today and paid off all debts, how much would I have?" For investors and lenders, equity shows whether the business is building value or eroding it.
For accountants and bookkeepers, equity is the balancing force on the balance sheet. Assets must always equal Liabilities plus Equity - it's the accounting equation that makes double-entry bookkeeping work. Every profit or loss, every distribution to the owner, every capital injection flows through equity. It's the hook that ties the P&L to the balance sheet.
For business owners deciding whether to reinvest earnings or distribute them, equity matters because building equity is how you fund growth without taking on debt. If your equity grows 20% a year, you're getting stronger. If it shrinks, you're burning through the business's net worth. Banks and investors look at equity before they look at revenue - strong equity means the owner has skin in the game.
Equity is calculated one way but understood in two directions.
The formula:
Equity = Assets - Liabilities
Pull your balance sheet. Count everything you own (cash, equipment, inventory, receivables, investments). Count everything you owe (bank loans, payables, tax liabilities, credit lines). Subtract the second from the first. That's equity.
The movement side is equally important. Each month, equity changes by:
Real example:
A freelance designer starts with £50,000 of personal savings invested in the business. That's equity. Year one, she earns £80,000 revenue and has £30,000 expenses, netting £50,000 profit. Equity grows to £100,000 (£50,000 initial + £50,000 profit). She has a business loan of £20,000 outstanding. Her balance sheet shows: Assets £100,000 (cash) + a business loan liability of £20,000. Equity = £100,000 - £20,000 = £80,000. In year two, she takes £30,000 as a distribution. Equity becomes £80,000 - £30,000 = £50,000.
Why equity is divided into two buckets:
Common mistakes:
Best practices:
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Equity is what the owner actually owns in the business. If your business has £100,000 in assets and owes £30,000 to creditors, your equity is £70,000. It's the difference between what you own and what you owe. As a small business grows and becomes profitable, equity grows because profit is retained in the business. Equity is also called owner's equity, shareholders' equity, or net worth.
In accounting, equity sits on the right side of the balance sheet as the ownership claim on the business's assets. It's calculated as Assets minus Liabilities. Equity is split into contributed capital (money the owner put in) and retained earnings (profit the business kept instead of distributing to the owner). Every journal entry that moves profit or loss flows through the equity section.
Owner's equity is the equity in a sole trader or partnership business - the net value that belongs to the owner(s). For a limited company, the equivalent term is shareholder's equity. Owner's equity increases when the business is profitable (earnings add to the pool) and decreases when losses occur. At year-end, the profit or loss from the P&L is added to retained earnings within owner's equity.
Equity = Assets - Liabilities. Pull your total assets from your balance sheet (cash, inventory, equipment, receivables, etc.). Pull your total liabilities (bank loans, payables, tax owed, credit lines). Subtract liabilities from assets and you have equity. You can also calculate it as: Beginning Equity + Net Profit - Distributions = Ending Equity. This second formula is useful for tracking how equity changed during the year.
Debt is money you borrow and must repay with interest - the lender has a fixed claim and expects repayment on a schedule. Equity is an ownership stake - the owner bears the risk and earns returns only if the business is profitable. A bank loan is debt; selling shares or reinvesting profit is equity. Most small businesses mix both: they might have a mortgage (debt) and the owner's original investment (equity).
A balance sheet is a financial statement that shows what your business owns (assets), what it owes (liabilities), and what's left for you as the owner (equity) at a specific moment in time. It follows the equation: Assets = Liabilities + Equity. Banks, investors, and accountants use it to assess your financial health.
Assets are anything of value owned by a business that can be converted into cash or used to generate revenue. They include cash, equipment, property, inventory, and intellectual property. Assets are listed on the left side of the balance sheet.