Equity, share capital and retained earnings explained

Equity is the part of a company’s value that belongs to its shareholders: total assets minus total liabilities. On a UK balance sheet it appears as “capital and reserves”, made up mainly of share capital, share premium and retained earnings. The split matters because only retained earnings, in the form of realised profits, can be paid out as dividends.

What is equity?

Equity is what would be left for shareholders if the company sold its assets at book value and paid every debt. It is also called net assets, shareholders’ funds or capital and reserves.

The balance sheet always balances on this equation:

Assets minus liabilities equals equity.

Equity is not cash in the bank. A company can have large retained earnings and an empty bank account, because the profit may be tied up in stock, debtors or equipment. See how to read a balance sheet for the full layout.

The parts of equity

Most small UK companies show three or four lines in capital and reserves.

What is share capital?

Share capital is the nominal (par) value of the shares a company has issued. If you form a company with 100 ordinary shares of £1 each, its share capital is £100, whatever the company later becomes worth.

Share capital stays on the balance sheet unless the company formally reduces it. Under section 641 of the Companies Act 2006, a private company can do that by special resolution backed by a directors’ solvency statement, or by special resolution confirmed by the court. Our guide to share capital covers share classes and allotments.

What is share premium?

Share premium is the amount investors pay above a share’s nominal value. Section 610 requires the company to transfer that excess to a share premium account.

The account can only be used to:

• write off the expenses and commission of the share issue that created it
• pay up new fully paid bonus shares for members

Otherwise it is treated like share capital, so you cannot pay dividends from it.

What are retained earnings?

Retained earnings are the company’s accumulated profits after Corporation Tax, less every dividend it has paid. They appear as the “profit and loss account” reserve. Each year the figure moves like this:

1. Start with retained earnings brought forward.
2. Add profit after tax for the year (or deduct a loss).
3. Deduct dividends declared in the year.
4. The result is retained earnings carried forward.

Corporation Tax comes off first: 19% on profits up to £50,000, 25% above £250,000, with marginal relief in between, according to GOV.UK.

Worked example

Brightline Ltd is formed with 100 ordinary £1 shares issued at par. In year 1 it makes £40,000 profit after tax and pays £25,000 of dividends. In year 2 an investor pays £20,000 for 10 new £1 shares, and the company breaks even.

The investor’s £20,000 increased equity, but only £15,000 is available for dividends. The share premium of £19,990 must stay in the company.

How much can you pay in dividends?

You can pay dividends only from profits available for distribution. Section 830 defines these as accumulated, realised profits not already distributed or capitalised, less accumulated, realised losses not written off. GOV.UK puts it simply: do not pay out more than the available profits from current and previous financial years.

Use this check before declaring a dividend:

• If retained earnings are positive and realised, you can usually pay up to that figure, based on up-to-date accounts.
• If the company has a deficit on the profit and loss account, you cannot pay a dividend until profits cover the loss.
• If the reserve includes unrealised gains, such as a revaluation, leave them out.
• If cash is short, profit alone is not enough; directors must still consider whether the company can pay its debts.

If a dividend breaks these rules, a shareholder who knew or had reasonable grounds to believe it was unlawful must repay it under section 847. Directors who take money that is not a lawful dividend should record it in the director’s loan account and take advice.

How dividends are taxed in 2026/27

Shareholders pay no tax on the first £500 of dividends. Above that, GOV.UK gives rates of 10.75% (basic rate), 35.75% (higher rate) and 39.35% (additional rate) for 2026/27. Our dividend tax calculator works out your bill, and how to declare a dividend covers the board minutes and vouchers.

Frequently asked questions

Is retained earnings the same as cash?

No. Retained earnings are an accounting total of profits kept in the business. The cash may have been spent on stock, equipment or loan repayments.

Can a company pay dividends from share premium?

No. Share premium can only cover share issue costs or fund bonus shares, unless the company formally reduces it under the capital reduction rules.

What happens if retained earnings are negative?

The company has an accumulated deficit and cannot pay a dividend until later profits clear it. It may still be solvent if it has enough share capital or other funding.

Where does equity appear in UK accounts?

It appears as “capital and reserves” at the foot of the balance sheet. It equals net assets, the figure above it.

Does issuing shares increase retained earnings?

No. New share money goes to share capital and share premium. Only profits after tax, less dividends, change retained earnings.