What is equity?

Equity represents the value of what your business owns after subtracting what the business owes. It is often referred to as "net assets" and appears on the balance sheet report. See FASB, Statement of Financial Accounting Concepts No. 8, Chapter 4, E61 to learn more.

This article explains the common categories of equity, how to distinguish equity from liabilities, and how specific transactions impact your balance sheet.

Common equity categories

• Owner Investments (sole proprietors), Partner Contributions (partnerships), or Common Stock (corporations): This is money the owner(s) invest in the business. It includes cash and non-cash investments.
• Additional Paid-in Capital (APIC) (corporations): This is the amount investors pay for shares in excess of the stock’s par value.
• Owner Draws (sole proprietors & partnerships): This is money owners take out for themselves. If you take money out of your business account to pay yourself from business earnings, it represents an owner's draw. Note, that if you need to pay that money back to the business, it's a loan to you (business assets) from the business and not an owner's draw.
• Partner Distributions (partnerships) / Dividends (corporations): These are distributions paid to partners or shareholders. This is how partners share earnings and corporations pay out earnings.
• Retained Earnings: These are accumulated profits kept in the business increased by net income and decreased by dividends declared. This is mainly for corporations that pay tax as their own entity instead of passing all profits through to their owners.

Common equity situations

Use the table below to determine the correct classification for common financial scenarios.

Equity vs. liabilities

It is common to confuse equity with liabilities. Money your business receives is not equity if there are still related obligations to transfer cash or assets.

Example 1: Loans from the owner to the business

Loans are not equity because the owner does not gain ownership from the loan and expects to be reimbursed in the future.

• These transactions lead to liabilities for the business.
• If the owner later forgives the loan or formally converts it to equity, the transaction is reclassified from liabilities to the equity account.

Example 2: Business expenses paid with personal accounts

When owners pay business expenses with personal funds:

• Liability: If the owner expects reimbursement, it is not equity.
• Equity: If the owner does not expect repayment, it is recorded as an equity contribution (Owner investment, Contribution, or APIC).

Accounting example: A corporation’s owner pays $5,000 of business expenses using a personal credit card.

1. When the expense is paid by the owner:
   • Debit: Operating expenses ($5,000)
   • Credit: Due to owner/Liability ($5,000)
2. When the owner is reimbursed:
   • Debit: Due to owner ($5,000)
   • Credit: Cash/Bank ($5,000)

Withdrawals of equity

A withdrawal of equity happens when an owner takes cash or other assets out of the business for personal use. These are recorded as reductions of equity, not expenses.

The following table summarizes how withdrawals impact balance sheets for different business types:

Disclaimer: This article is provided for general informational and educational purposes only and is not intended to provide accounting, tax, legal, or financial advice.