What impact does net profit have on equity?

Net profit has a direct positive impact on equity, which is reflected in the retained earnings section of shareholders' equity in the balance sheet. When a company earns a profit, this amount is added to retained earnings, thus increasing the overall equity of the company. This increase in equity signals a stronger financial position, as it represents the cumulative profits that have been reinvested in the business rather than distributed as dividends.

In this context, a higher net profit can also enhance the company’s ability to raise funds, attract investors, and pursue growth opportunities, all of which contribute to the overall value of the company. Therefore, the correct understanding is that net profit increases equity, reinforcing the relationship between profitability and shareholder value.