Equity in accounting is the part of the business that belongs to the owners: everything the business owns, minus everything it owes. It sounds academic, but it drives practical decisions every month, such as how you pay yourself, whether you can borrow, and whether money you took out last year is about to become a tax problem.
This guide explains owner’s equity and shareholders’ equity, how retained earnings build up, the difference between drawings and dividends, and why company owners need to watch Division 7A. Rates and rules for the 2025-26 and 2026-27 income years were checked against ATO Division 7A guidance, the ATO benchmark interest rate table and ASIC financial reporting pages.
It is written for sole traders, partners and directors of small private companies who want to read their own balance sheet with confidence. If you are thinking about changing structure, our guide to moving from sole trader to company covers that decision in more detail.
Key takeaways
- Assets – liabilities = equity. Equity is the owners’ share of the business on a given date.
- Sole traders take drawings, which reduce equity but are not a tax deduction.
- Companies pay owners through wages, director’s fees or dividends. Taking cash any other way is usually a loan.
- A loan from a private company to a shareholder can become an unfranked deemed dividend under Division 7A unless repaid or put on complying terms before the company’s lodgment day.
- Division 7A benchmark interest rate: 8.37% for 2025-26 and 8.77% for 2026-27.
- Most small proprietary companies do not lodge financial reports with ASIC unless asked, but still need accurate accounts.
Equity at a glance
| Item | Sole trader or partnership | Private company |
|---|---|---|
| What equity is called | Owner’s equity or capital | Shareholders’ equity |
| Main components | Capital contributed + profits – drawings | Share capital + retained earnings + reserves |
| How owners take money | Drawings (not deductible) | Wages, director’s fees, dividends or a complying loan |
| Tax on profit | Owner’s individual rates | Company rate (25% base rate entity or 30% for 2025-26) |
| Main equity risk | Mixing business and personal spending | Division 7A deemed dividends |
| ASIC financial report | Not applicable | Usually not lodged by small proprietary companies |
Source: ATO Division 7A, ATO benchmark interest rate, ATO company tax rates 2025-26, ASIC small proprietary companies, checked 9 October 2026.
What does equity actually mean on a balance sheet?
Think of your business as a house with a mortgage. The value of the house is the asset, the mortgage is the liability, and the part you own outright is equity. The balance sheet works the same way, just with more lines.
For example, a small plumbing business with $90,000 of assets (cash, debtors, tools and a van) and $28,000 of liabilities (a van loan, supplier bills, a credit card and GST payable) has equity of $90,000 – $28,000 = $62,000.
Equity is not cash. A business can have strong equity tied up in equipment and debtors and still struggle to pay its BAS on time. That is why equity should be read alongside the profit and loss statement and cash flow. Our profit and loss statement guide explains how the two reports connect, and our financial management and reporting service can prepare both for you.
What makes up equity for different structures?
Sole traders and partnerships
Owner’s equity usually has three moving parts: money or assets you put in, profit the business earns, and drawings you take out. Profit increases equity. Losses and drawings reduce it.
Companies
A company is a separate legal entity, so its equity belongs to shareholders rather than to you personally. It typically includes:
- Share capital: the amount shareholders paid for their shares. Many small companies start with a nominal amount.
- Retained earnings: accumulated after-tax profits that have not been paid out as dividends.
- Reserves: amounts set aside for particular purposes, such as an asset revaluation reserve.
Retained earnings move each year by a simple formula: opening balance + profit after tax – dividends paid = closing balance. If the year-end close is never done, the balance sheet will not reconcile.
Drawings vs dividends: how do owners take money out?
This is where most equity errors happen, and where the tax consequences are real.
| Method | Who uses it | Effect on equity | Tax treatment |
|---|---|---|---|
| Drawings | Sole traders, partners | Reduces owner’s equity | Not deductible; tax is on business profit |
| Wages or director’s fees | Company employees and directors | Reduces profit, so retained earnings | Deductible to the company; taxable to the person; PAYG withholding and reporting apply |
| Dividends | Company shareholders | Reduces retained earnings | Assessable to the shareholder; may carry franking credits |
| Loan from the company | Shareholders and associates | Recorded as an asset of the company (loan receivable) | Can be a deemed unfranked dividend under Division 7A unless managed |
The ATO’s page on using business money and assets for private purposes says you must keep records that explain any money or assets you take or use privately. Its sole trader example makes the key point: business income is reported as business income regardless of how much was transferred to a personal account.
For directors weighing a wage against director’s fees, see our guide to director’s fees in Australia.
What is Division 7A and why does it matter for equity?
Division 7A is part of the Income Tax Assessment Act 1936. The ATO says it is intended to stop private company profits or assets being provided to shareholders or their associates tax free.
A payment, loan, or forgiven debt to a shareholder or associate can be treated as a dividend for tax purposes, even if the parties call it something else. A Division 7A deemed dividend is generally unfranked, so the shareholder pays tax on it without a franking credit for company tax already paid.
How to avoid a deemed dividend
The ATO says a payment or benefit is not treated as a dividend if it is repaid, or converted into a complying loan, by the company’s lodgment day for that income year. Under the ATO’s loan rules, a complying loan needs:
- a written agreement in place before the company’s lodgment day
- interest at least equal to the benchmark interest rate each year (8.37% for 2025-26, 8.77% for 2026-27)
- a maximum term of 7 years, or 25 years if the whole loan is secured by a registered mortgage over real property
- minimum yearly repayments in each year after the year the loan is made
The ATO also notes that often the most effective approach is simply to pay a normal dividend, franked where possible, and have the shareholder declare it. For a deeper look at trust distributions and Division 7A, read our Bendel case explainer.
Worked example: retained earnings and a director’s loan
A two-shareholder trades company has share capital of $100. At 1 July 2025 its retained earnings were $40,000.
For 2025-26 it makes a profit after tax of $60,000 and pays a $20,000 dividend. Closing retained earnings = $40,000 + $60,000 – $20,000 = $80,000. Total equity = $80,000 + $100 = $80,100.
During the year, one director also moved $15,000 from the company account to pay a personal credit card. It was not a wage or a dividend, so it sits in the books as a $15,000 loan owed by the director to the company.
Before the company’s lodgment day, the director either repays the $15,000, puts it under a written complying loan agreement charging at least 8.37% for 2025-26, or the company declares it as a dividend. If nothing is done, Division 7A can treat the $15,000 as an unfranked dividend in the director’s own return.
Do you need to report equity to ASIC or the ATO?
For tax, the company tax return and the individual returns of shareholders capture profit, dividends and loan balances, and the ATO expects your records to support them. Business records generally need to be kept for 5 years and must explain the purpose of each transaction.
For corporate reporting, ASIC says small proprietary companies generally only prepare a financial report if shareholders request it, ASIC directs it, or special rules apply (such as foreign control or crowd-sourced funding). A proprietary company is large if it meets two of three tests: revenue of $50 million or more, gross assets of $25 million or more, or 100 or more employees, per ASIC’s size tests. You can find company obligations on the ASIC website.
How does equity support business growth?
Lenders look at equity because it shows how much of the business is funded by the owners rather than debt. Growing retained earnings tell them the business is profitable and keeping some of that profit to fund its own growth. Negative equity, where liabilities exceed assets, is a warning sign that needs attention.
When you need funding, the choice is usually between debt (borrowing and repaying with interest) and equity (selling part of the business). Debt keeps ownership intact but needs reliable cash flow. Equity finance brings capital without repayments but dilutes control. Wider conditions matter too; the RBA explainer on trends in Australia’s balance of payments shows how capital flows in the economy shift over time. Our business finance and capital support team can help you prepare for either path, and a business valuation is the starting point if you are selling a stake.
Rule of thumb: If money leaves a company and it is not a wage, director’s fee or declared dividend, treat it as a Division 7A loan and deal with it before the company’s lodgment day.
Common mistakes with equity accounting
- Coding personal spending as business expenses: it overstates expenses and understates profit. Record it as drawings (sole trader) or against the director’s loan account (company).
- Treating company money as your own: directors who take cash like a sole trader create Division 7A loans without realising.
- Missing the year-end close: if profit is not transferred to retained earnings, the balance sheet will not balance.
- Letting loan accounts drift: a debit director’s loan that is not repaid or documented before lodgment day can become an unfranked dividend.
- Reading equity as cash: strong equity does not guarantee you can meet BAS, payroll or super payments on time.
FAQ about equity in accounting
What is equity in accounting?
Equity is what is left for the owners after you take everything the business owes away from everything it owns. The formula is assets minus liabilities. For a sole trader or partnership it is usually called owner’s equity or capital. For a company it is shareholders’ equity, made up mainly of share capital, retained earnings and any reserves.
Are drawings a tax deduction for a sole trader?
No. Money a sole trader takes out of the business for personal use is drawings, not a wage or business expense. It reduces owner’s equity on the balance sheet but does not reduce taxable profit. The sole trader pays tax on the net business profit at individual rates, regardless of how much was transferred to a personal account during the year.
Can a company director take money out like a sole trader?
Not in the same way. A company is a separate legal entity, so money taken by a shareholder or director must be a wage, director’s fee, dividend or loan. If it is treated as a loan, Division 7A can deem it an unfranked dividend unless it is repaid or put under a complying loan agreement before the company’s lodgment day.
Are retained earnings taxed?
Retained earnings are profits that have already gone through the company tax return, so they have generally already been taxed at the company rate. When those profits are later paid out as dividends, shareholders include the dividend in their own assessable income and may receive franking credits for company tax already paid, depending on the company’s franking account.
Do small companies have to lodge a balance sheet with ASIC?
Generally no. ASIC says most small proprietary companies do not need to prepare or lodge financial reports unless shareholders request one, ASIC directs it, or special rules apply, such as foreign control or crowd-sourced funding. The company still needs accurate accounts to complete its tax return, and the ATO expects records that explain every equity transaction.
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This article is general information only and is not personal tax or legal advice. Figures and rules were checked against the ATO Division 7A, benchmark interest rate, company tax rate and record-keeping pages, and ASIC financial reporting pages on 9 October 2026. Rates and thresholds change, so confirm the current position before acting.
