Owner’s equity is the dollar value of your stake in a business: what the business owns minus what it owes. The formula is Assets minus Liabilities equals Owner’s Equity. If your company holds $500,000 in assets and carries $200,000 in liabilities, your equity is $300,000. That figure moves every time the business earns a profit, absorbs a loss, takes in a new contribution, or pays money out to you.
How the Calculation Works
Every transaction the business records has to keep the equation in balance. Buy a $10,000 piece of equipment with cash and your assets stay the same: cash drops, equipment rises. Finance that same equipment with a loan and both assets and liabilities go up by $10,000, so equity is unchanged. The equation isn’t a shortcut; it’s the structural logic behind double-entry bookkeeping.
The formula also rearranges. If you know equity and liabilities, you can back into total assets. If you know assets and equity, you can figure out how much debt the business is carrying. Lenders and investors run those calculations routinely to see how a company is funded.
What Sits Inside the Equity Section
The accounts that make up equity depend on how the business is organized.
Sole Proprietorships and Partnerships
A sole proprietor has a single capital account. It tracks personal money and property invested in the business plus accumulated profits that haven’t been withdrawn. The balance goes up with contributions and income, and down with draws. Partnerships work the same way, except each partner has a separate capital account. Those individual accounts drive how profits are split and what each partner would receive if the business liquidated.
A partner’s tax basis in the business starts with the money and adjusted value of any property contributed.1Office of the Law Revision Counsel. 26 USC 722 – Basis of Contributing Partners Interest Basis then adjusts upward for income and additional contributions, and downward for distributions and losses.
Corporations
Corporate equity, usually called stockholders’ equity, is more granular. Common stock records the par value of shares issued. Additional paid-in capital captures anything shareholders paid above par. Retained earnings hold cumulative profits the company has kept rather than distributed as dividends. You may also see accumulated other comprehensive income, which covers certain unrealized gains and losses that bypass the income statement.
Treasury stock is a corporate-only account worth knowing. When a corporation buys back its own shares, the repurchased shares sit in a contra-equity account that reduces total stockholders’ equity. The shares aren’t retired; the company holds them and can reissue them later. Since 2023, corporations also owe a 1% federal excise tax on the fair market value of shares they repurchase.2Office of the Law Revision Counsel. 26 USC 4501 – Repurchase of Corporate Stock
LLCs
Limited liability companies sit in between. Like partnerships, LLCs maintain separate capital accounts for each member, and those accounts carry real weight when it comes to distributions and buyouts. Unlike corporations, there’s no stock or par value involved. Most multi-member LLCs follow partnership accounting rules. Single-member LLCs are treated as sole proprietorships for tax purposes unless the owner elects otherwise.
What Increases Owner’s Equity
Equity grows two ways: earning profits and putting more money in.
Net income is the engine. When revenue exceeds expenses for a period, the leftover profit flows into retained earnings for a corporation, or straight into your capital account if you’re a sole proprietor or partner. Every dollar of profit increases your claim on the business’s assets. This is the sustainable path to building equity, and it’s the one lenders most want to see.
Owner contributions are the other lever. Moving personal cash into the business, contributing a vehicle, or signing over real estate all increase your equity. For partnerships, each contribution also increases the contributing partner’s tax basis dollar for dollar, or by the property’s adjusted basis if the contribution isn’t cash.3eCFR. 26 CFR 1.722-1 – Basis of Contributing Partners Interest Contributions strengthen the balance sheet quickly, but they come from your pocket, so they don’t reflect business performance the way profits do.
What Decreases Owner’s Equity
Equity shrinks when the business loses money or when you pull money out.
A net loss means the business spent more than it earned. Expenses, interest, depreciation, and write-offs all eat into equity when they exceed revenue. One bad quarter won’t necessarily destroy the business, but sustained losses erode your capital account until there’s nothing left, and eventually push equity into negative territory.
Owner draws and distributions are the other drain. Whether you take $5,000 for personal bills or $50,000 as a quarterly distribution, the business’s cash goes down while its debts stay the same. For partnerships, distributions reduce your tax basis in the partnership.4Office of the Law Revision Counsel. 26 USC 733 – Basis of Distributee Partners Interest For corporations, dividend payments work the same way on the balance sheet: cash leaves, retained earnings drop, total equity falls. Frequent withdrawals that outpace profits are where most small-business equity problems start.
Calculating Equity Across a Period
The statement of owner’s equity exists to explain how the number changed from the start of a period to the end. The formula is straightforward:
Beginning Equity + Contributions + Net Income − Draws = Ending Equity
Say you started the year with $120,000 in equity, contributed $15,000, earned $45,000 in net income, and withdrew $30,000. Your ending equity is $150,000. That ending balance has to match the equity figure on your balance sheet. If it doesn’t, something is recorded wrong.
On the balance sheet itself, equity appears after liabilities. That arrangement lets anyone reading the report see immediately how the business is funded: how much comes from creditors and how much comes from the owner. For corporations, the equity section lists common stock, additional paid-in capital, retained earnings, and any treasury stock deduction separately. For sole proprietors, it’s usually a single capital line.
Book Value vs. Market Value
The equity figure on your balance sheet is book value. It reflects historical costs: what you originally paid for assets, minus accumulated depreciation, minus liabilities. Book value is precise and auditable, but it can be very different from what your business is actually worth.
Market value accounts for things the balance sheet ignores: brand recognition, customer relationships, future earnings, and what a buyer would actually pay. A consulting firm with minimal physical assets might show $50,000 in book equity but sell for $500,000 because of its client base and recurring revenue. A restaurant that spent heavily on renovations might show $300,000 in book equity but be worth less than that if the neighborhood is declining.
The IRS acknowledges the gap. When valuing an interest in a closely held business, the relevant factors include not just net worth but also earning power, industry outlook, competitive position, and goodwill.5Internal Revenue Service. Determining the Value of Donated Property (Publication 561) The distinction matters most during a sale, a buyout, or estate planning, when someone has to determine what your ownership stake is really worth rather than what the books say.
When Equity Goes Negative
Negative equity means liabilities exceed assets. The IRS defines insolvency the same way: total liabilities greater than total assets.6Internal Revenue Service. What if I Am Insolvent? It isn’t automatically fatal, but it signals serious financial distress.
Insolvency does have one tax benefit. Normally, when a creditor forgives a debt, you owe income tax on the forgiven amount. An insolvent taxpayer can exclude forgiven debt from income to the extent of the insolvency, reported on Form 982.6Internal Revenue Service. What if I Am Insolvent?
Operationally, negative equity makes borrowing nearly impossible, scares off investors, and may trigger default clauses in existing loan agreements that require a minimum net worth. For LLCs and corporations, negative equity combined with sloppy financial practices raises the risk that a court will disregard the business’s liability protection and hold the owners personally responsible for business debts. Courts look for signs that the business and personal finances have been treated as interchangeable: mixing funds in the same accounts, failing to keep separate books, or draining the company of assets while debts pile up.
Why the Number Matters to Lenders
When you apply for a business loan, the lender doesn’t look at your equity balance in isolation. They calculate your debt-to-equity ratio: total liabilities divided by total equity. A ratio around 1 to 1.5 is generally considered healthy, meaning the business has roughly as much equity as debt. Ratios above 2 raise flags because the business is heavily leveraged, and a downturn could leave it unable to service its debt. Capital-intensive industries like manufacturing and real estate routinely run higher ratios without alarm, so context matters.
The SBA applies equity requirements directly. For startup businesses and complete changes of ownership, SBA-backed loans typically require a minimum equity injection of at least 10% of total project costs. For existing businesses seeking working capital or equipment loans, the injection requirement may be waived, but the SBA still evaluates the debt-to-equity ratio on the balance sheet.
That’s the practical reason to care about the number beyond the accounting. A strong equity position gives you borrowing power, negotiating leverage with investors, and a cushion to survive slow periods. A weak one forces you to accept unfavorable loan terms or give up more ownership to raise capital. Every profit you reinvest and every unnecessary draw you skip quietly builds the figure that lenders and investors check first.