What is equity?
In accounting, equity is what would be left for the owners if the business sold all its assets and paid all its debts. It's the third element of the [accounting equation](/glossary/accounting-equation):
Equity = Assets − Liabilities
In a company it's called shareholders' equity; in a sole trader or partnership, owner's equity or capital.
Components of equity
- Share capital / owner's capital: money invested by owners
- Share premium: amounts paid above the nominal value of shares
- [Retained earnings](/glossary/retained-earnings): accumulated profits not paid out as dividends
- Other reserves: such as revaluation or foreign currency reserves
- Drawings or [owner's draws](/glossary/owners-draw): reduce equity in unincorporated businesses
What changes equity
- Increases: new investment, profits
- Decreases: losses, [dividends](/glossary/dividend), drawings, share buybacks
Example
A business has $500,000 of assets and $320,000 of liabilities. Its equity is $180,000.
Negative equity
If liabilities exceed assets, equity is negative. This is a warning sign of insolvency risk, though some fast-growing startups operate this way for a time.
Key ratios
- Return on equity (ROE) = Net income ÷ Average equity
- Debt-to-equity = Total liabilities ÷ Equity