What does equity represent in the context of financial statements?

Equity represents the owner's residual interest in the assets of a business after all liabilities have been deducted. This means that equity reflects what is truly owned by the shareholders or owners once all debts and obligations to creditors have been settled. It can be thought of as the net worth of the business, representing the claims that the owners have on the assets remaining after meeting liabilities.

In financial statements, equity includes common stock, retained earnings, and additional paid-in capital, among other components. Understanding equity is crucial because it indicates the financial health of a business and its ability to absorb losses, invest in growth, and provide returns to shareholders. This concept is central to the accounting equation: Assets = Liabilities + Equity, highlighting how equity balances the equation by providing a stake for the owners.