What is equity in business?
Learn what equity in business means, how to calculate it, and why it matters for your small business.
June 2023 | Published by Xero
Published Wednesday 12 August 2026
Table of contents
Key takeaways
- Equity is the value left in a business after subtracting its liabilities from its assets, representing what the owner would keep if the business were sold and all debts paid
- Positive equity means assets exceed liabilities, while negative equity signals potential insolvency and may prevent further trading under South African law
- You can grow your business equity by increasing profits, reinvesting earnings and paying down debt over time
- Equity is recorded on the balance sheet and reported in your year-end financial statements, including the statement of changes in equity
What is equity in business?
Equity is the ownership value left in a business after you subtract what it owes (liabilities) from what it owns (assets). It represents the money you would keep if you sold everything the business owns and settled all its debts.
When your assets are worth more than your liabilities, you have positive equity. When liabilities exceed assets, the business has negative equity, which can indicate insolvency. In South Africa and many other countries, trading while insolvent is illegal, so monitoring your equity position is essential.
The term "equity" can also refer to an ownership stake in a company, such as shares held by investors or founders.
The accounting equation: how equity fits the balance sheet
Equity sits within the fundamental accounting equation that governs every balance sheet. The equation is Assets = Liabilities + Equity. Rearranged, this becomes Equity = Assets − Liabilities.
Your balance sheet displays this relationship, with assets on one side and liabilities plus equity on the other. Equity represents the portion of your business that belongs to the owners after all obligations are accounted for.
How to calculate equity in business
To calculate your business equity, list all your assets, total them, then do the same for your liabilities. Subtract total liabilities from total assets, and the result is your equity. Here is an example in South African rands.
Total assets:
- Property and equipment: R500,000
- Inventory: R80,000
- Cash in bank: R45,000
- Accounts receivable: R75,000
- Total assets: R700,000
Total liabilities:
- Business loan: R200,000
- Amounts owed to suppliers: R60,000
- Tax owed: R40,000
- Total liabilities: R300,000
Equity = R700,000 − R300,000 = R400,000. This positive equity means the business has more assets than it owes.
If, for example, the same business had total liabilities of R800,000 against R700,000 in assets, equity would be negative R100,000. This negative equity indicates the business owes more than it owns.
Equity vs owner's equity, shareholders' equity and net worth
These terms all describe the same underlying value: what remains after liabilities are subtracted from assets. The specific term depends on the business structure.
For sole proprietors and partnerships, the figure is typically called owner's equity. For companies with shareholders, it is referred to as shareholders' equity. The term net worth means the same thing and is often used interchangeably, particularly when discussing personal or small business finances.
Components of equity
Equity is made up of several parts that together reflect the ownership value of a business.
- Share capital (contributed capital): the money shareholders have invested in exchange for shares
- Retained earnings: accumulated profits that have been kept in the business rather than paid out as dividends
- Treasury shares: shares the company has bought back from shareholders, which reduce total equity
Types of equity
Equity takes different forms depending on the context. In a company, it typically refers to ownership through shares, but the word appears in other financial settings too.
- Common shares: standard ownership stakes that give shareholders voting rights and a share of profits
- Preferred shares: shares that typically pay fixed dividends and have priority over common shares if the company is liquidated
- Private equity: ownership stakes in companies that are not publicly traded, often held by investment firms
- Home equity: the portion of a property's value that belongs to the owner after deducting any mortgage
- Brand equity: the commercial value of customer perception and recognition of a brand name
Equity financing vs debt financing
When you need capital to grow your business, you have two main options: equity financing or debt financing. Understanding the trade-offs helps you choose the right approach for your situation. You can explore business finance options to learn more about the alternatives.
Equity financing means selling a portion of ownership in your business to investors. You receive funds without taking on debt, but you give up some control and a share of future profits. Debt financing means borrowing money, typically through a loan. You keep full ownership, but you must repay the borrowed amount plus interest, regardless of how the business performs.
For small businesses, equity financing avoids repayment pressure but dilutes ownership. Debt financing preserves ownership but adds fixed obligations to your cash flow.
Why equity matters
Your equity position influences how others view your business and affects your options when you need funding or want to sell.
- Selling the business: buyers look at equity to assess the value you have built
- Lenders: banks and other lenders use equity as a sign of financial health before approving loans
- Investors: potential investors evaluate equity to understand ownership structure and the value of their potential stake
- Insurers: some insurers consider equity when assessing business risk
- Owners and employees: equity represents the accumulated value that benefits owners and, in some cases, employees with share options
How equity changes over time and how to grow it
Equity is not static. It rises and falls based on your business activities and financial decisions. Profits add to equity through retained earnings, while losses reduce it. When you take out a loan to buy an asset, the new asset and the new liability roughly offset each other at first. As you repay the loan, the liability decreases and your equity rises. Good small business accounting helps you track these changes over time.
Ways to grow your equity:
- increase your profits by raising revenue or reducing costs
- reinvest earnings back into the business rather than withdrawing them
- pay down existing debt to reduce liabilities
Negative equity can develop from sustained losses, excessive borrowing, writing down asset values or taking too many owner withdrawals. Monitoring your balance sheet regularly helps you spot problems early.
Return on equity (ROE)
Return on equity measures how efficiently a business generates profit from its equity. Lenders and investors use it to compare performance across companies and assess how well management is using shareholder funds.
The formula is ROE = net income ÷ shareholders' equity, expressed as a percentage. A higher ROE indicates the business is generating more profit relative to its equity base. You can find ROE alongside other profitability ratios in financial analysis.
Where equity is recorded and how it's reported
Equity appears at the bottom of the balance sheet, after assets and liabilities. It is calculated at the end of each accounting period and forms part of your year-end financial statements.
The statement of changes in equity shows how equity has moved during the period, including contributions, withdrawals, profits and losses. This statement is one of the financial statements required under International Financial Reporting Standards (IFRS). South African companies typically follow IFRS, though smaller entities may use IFRS for SMEs.
Track your business equity with Xero
Keeping an eye on your equity helps you understand your business's financial position and plan for growth. Xero's accounting software gives you real-time balance sheets and financial reports so you can see your equity at a glance. Ready to take control of your finances? You can get one month free and start tracking your business equity today.
FAQs on equity
Here are answers to common questions about business equity.
What is the difference between equity and net worth?
Equity and net worth mean the same thing in business terms. Both represent the value remaining after you subtract liabilities from assets.
What is the difference between equity and shares?
Equity is the total ownership value in a business, calculated as assets minus liabilities. Shares are units of ownership that represent a portion of that equity.
Can business equity be negative, and what causes it?
Yes, equity becomes negative when liabilities exceed assets. This can result from accumulated losses, excessive borrowing, asset write-downs or large owner withdrawals.
What is the difference between equity financing and a business loan?
Equity financing involves selling part of your business to raise capital, while a business loan is borrowed money you must repay with interest. Equity financing dilutes ownership; a loan does not.
How can I increase my business's equity?
Grow equity by increasing profits, reinvesting earnings into the business and paying down debt. Avoiding excessive owner withdrawals also helps preserve equity over time.
Related terms
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Disclaimer
This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.