What Is Equity on the Balance Sheet and Why It Matters for SMEs

Introduction

In construction and engineering, directors are often focused on turnover, gross profit, or cash flow, but overlook the importance of equity on the balance sheet. Equity represents the value of ownership in your business after liabilities are taken away from assets.

In simple terms, it’s “what’s really yours.” Many SMEs misunderstand equity, assuming it’s only relevant when talking to investors or accountants.

The truth? Equity is a vital measure of financial health that affects borrowing power, growth opportunities, and even exit planning. At Jones Financial Accounts (JFA), we help SMEs translate their balance sheet into practical insights, so directors can make informed decisions instead of guesses.

Why Equity Is Important

Equity is the difference between assets (what you own) and liabilities (what you owe). For example, if your company owns £1m in equipment, cash, and receivables, but owes £600k in loans and payables, equity equals £400k. This figure matters because it shows the “net worth” of the business.

For SMEs in construction and engineering, equity provides reassurance to directors, suppliers, and lenders. A strong equity position signals financial stability, which makes it easier to win contracts, negotiate supplier credit, and attract funding. On the other hand, low or negative equity suggests that liabilities outweigh assets, a red flag for potential insolvency.

Equity also plays a big role in shareholder confidence. If you’re working with multiple directors or external investors, equity determines how much value they hold. For SMEs, this isn’t just an accounting term, it’s the financial foundation of the business’s reputation and resilience.

Impact of Equity on the Business

A healthy equity position gives your business credibility and room to grow. Lenders are more likely to approve funding because they see the company has a solid base. Directors can reinvest retained earnings (profits kept in the business) instead of relying purely on debt. Over time, equity growth reflects the company’s success and strengthens long-term sustainability.

If equity is ignored, directors may continue paying dividends they can’t afford, stripping the business of stability. Poor equity weakens your ability to negotiate with banks or suppliers. For SMEs, this can mean higher borrowing costs or being denied contracts that require strong balance sheets.

In the worst cases, sustained negative equity leads to insolvency, even if the company appears profitable on the surface.

Equity is not just an accounting figure; it’s the backbone of financial resilience.

The Connection Between Cash Flow and Equity

Cash flow and equity may sit on different reports, one on the cash flow statement, the other on the balance sheet, but they are deeply connected. Strong cash flow builds equity, while weak cash flow erodes it.

When your business generates positive cash flow, you can reduce liabilities (e.g. paying down loans) or increase assets (e.g. saving cash, buying equipment outright). Both actions strengthen equity because they improve the balance sheet. For example, paying off a £50k loan doesn’t just improve your cash position; it also increases net assets by the same amount, lifting equity.

On the flip side, poor cash flow forces directors to borrow more or dip into reserves. Rising liabilities or depleted assets drag equity down. A business might still show profits in the P&L, but if cash flow is negative, equity gradually weakens.

That’s why lenders and investors look at both: profits without cash don’t build resilience, while strong cash management feeds directly into equity growth.

For SMEs in construction and engineering, where delayed payments and retention money can tie up large amounts of cash, the link is especially critical.

Good cash management keeps equity strong, and strong equity, in turn, boosts confidence with banks and clients, creating a positive cycle.

Strategy: How to Strengthen Equity in Your Business

1. Retain profits instead of always distributing them. Keeping some earnings in the business builds reserves and increases equity.

   
   

2. Manage debt carefully. Borrow strategically, not reactively. Debt should be used to fund growth, not to cover ongoing losses.

   
   

3. Track equity monthly. Review your balance sheet regularly, not just at year-end. Spot declining equity early and take action.

   
   

4. Invest in productive assets. Machinery, systems, or staff that drive long-term revenue improve equity value, rather than just short-term profit.

   
   

5. Avoid overpaying directors. Excessive dividends or salaries reduce equity and put future stability at risk.

   
   

For SMEs, particularly in construction and engineering, strengthening equity means building trust with lenders, suppliers, and clients. It’s a sign that you’re not only profitable today but sustainable tomorrow.

Real Numbers

A £2m-turnover scaffolding firm had equity of just £50k due to years of high dividends and debt-funded equipment purchases. When bidding for a large contract, the client requested financial statements and flagged weak equity as a risk.

By restructuring, retaining £100k of profit instead of distributing it, and reducing debt by £75k, the company lifted equity to £225k within two years. The result? Access to cheaper borrowing and success in securing contracts worth over £500k annually.

Misconceptions About Equity

• “Equity only matters if you want investors.” Wrong, lenders, suppliers, and even clients review equity to judge your stability.

  
  

• “If I’m profitable, equity takes care of itself.” Not always. High dividends or excessive debt can erode equity despite profits.

  
  

• “Small businesses don’t need to worry about equity.” SMEs are at higher risk; weak equity makes it harder to survive downturns or secure finance.

Key Takeaways

• Equity is the value of your business after liabilities, the real financial backbone.

• A strong equity position builds trust with lenders, suppliers, and clients.

• Strong cash flow feeds equity growth, while weak cash flow erodes it.

• Retained profits, controlled debt, and smart investment grow equity sustainably.

At JFA, we help SMEs in construction and engineering understand and strengthen equity, turning balance sheet numbers into practical tools for growth.

Wrapping up today's insights, tomorrow we simplify another accounting challenge.