What is the relationship between total equity and net profit?

The relationship between total equity and net profit is accurately described by the statement that total equity equals owner's equity plus net profit. This reflects the fundamental accounting equation where equity represents the residual interest of the owners in a business after liabilities have been deducted from assets.

When a business earns net profit, this profit adds to the owner's equity, enhancing the overall financial position of the business. Net profit, being the remaining income after all expenses have been deducted from total revenue, directly contributes to the equity on the balance sheet at the end of a reporting period. Therefore, an increase in net profit typically results in an increase in total equity over time, reflecting the overall profitability and financial health of the business.

This understanding is crucial because it illustrates how a business's profitability impacts its long-term sustainability and the financial returns for its owners. Financial decision-making should consider this dynamic, as retaining earnings (net profits) within the business can fuel further growth and improve equity.