How to Prorate a Bill: The Ultimate Guide

In an age where subscription-based products and services dominate the consumer sphere, understanding proration is a must for businesses and customers alike. In this article, we’ll discuss prorated billing in depth.

Get acquainted with the pro rata definition; understand prorated charges, salary, and rent; and learn how to calculate prorated rates to deliver and take advantage of fairer and more advantageous pricing structures.

Key Takeaways

• Prorated billing charges customers based on service usage within a billing period.
• It adjusts charges when customers change plans mid-cycle.
• Helps companies comply with revenue recognition standards.
• Automated invoicing tools simplify and reduce errors in prorated billing.

What Does Prorated Mean?

Since its first documented use in 1894, the word “prorated” has gained exponential significance in numerous aspects of our everyday lives, including investment, real estate, employment, and standard consumer purchases. 

Across all these spheres, the word prorated has come to mean payment or investment made in proportional value to the specific quantity or period of a product/service used to account for variation and ensure end customers don’t overpay.

Prorated Definition

The word “prorated” stems from the Latin term “pro rata,” which describes proportional allocation. According to the Merriam-Webster Dictionary, prorated can be defined as:

“Something divided, distributed, or assessed proportionally as to reflect an amount of time that is less than the full amount included in an initial arrangement.”

What Is Prorated Billing?

Prorated (a.k.a. proportionate, usage-based, or partial-period) billing is a form of billing that allows businesses to charge customers based on the exact amount of a product or service they’ve used within a billing cycle. This is in contrast to standard billing, which charges full price regardless of true usage.

Although prorated billing requires more work on the business’s side, it offers a worthwhile trade-off. It ensures fairness and accuracy that customers are sure to appreciate.

What Are Prorated Charges?

Prorated charges, as part of prorated billing, are incurred when the usage of a product or service doesn’t perfectly align with the standard billing cycle. For example, if a monthly subscription costs $30, but you only use it for 15 days, you pay $15 end of the month.

Prorated charges help ensure that the customer pays a fair amount relative to their usage rather than a full monthly fee. This is particularly worthwhile when a user starts or cancels their subscription part-way through the billing cycle.

Prorated vs. Standard Billing

Why Is Proration Important?

Proration and prorated billing are highly important in building a pro-customer business by ensuring fair pricing for all your customers. And as we’ll discuss in the following section, it also offers several desirable knock-on benefits.

Generally speaking, this includes encouraging customer trust and loyalty by delivering fair and transparent payments and improving both your company’s and client’s flexibility to experiment with higher-tier pricing plans.

Prorated Billing Benefits

The biggest benefits of prorated billing for customers include:

• Lower prices for partial product or service usage,
• Flexibility in terms of starting, changing, or ending subscriptions,
• Fair and transparent billing.

Meanwhile, the biggest benefits of prorated billing for companies include:

• Higher customer satisfaction and loyalty,
• Higher likelihood of subscription renewal,
• Increased customer lifetime value (CLV),
• A competitive advantage in terms of transparency and fairness.
  

Prorated Billing Disadvantages

Suffice it to say that prorated billing has essentially no disadvantages for the end customer. Unfortunately, the same can’t be said for businesses. If you’re considering implementing proration into your pricing structure, you should be wary of:

• Potentially lower stable revenue,
• Limited proration possibility for some services,
• Higher requirements for calculation and bookkeeping,
• Poor customer understanding of the proration system.

How Does Prorated Billing Work?

As previously explained, prorated billing allows businesses to accurately charge their customers for products and services without losing customers to overcharging or money to undercharging. 

You can do so by only charging customers for the amount (of time) that they’ve actually used your products or services – for example, 15 out of 30 days in a month. However, this approach requires a little more work than standard flat pricing plans. 

This includes being able to:

1. Accurately track the actual amount/period of use,
2. Adapt to changes to the subscription mid-billing period,
3. Charge customers based on their actual usage in a timely way.

As such, companies that want to incorporate prorated billing into their operations need to have a sufficiently sizeable financial department to handle the additional tasks required to track, change, calculate, and charge for subscriptions accurately.

How Is Prorated Billing Calculated?

As mentioned, proration requires a significant amount of accurate calculations to do well. Often, this can be addressed with specialized software, though it isn’t strictly required. Below, you’ll find a step-by-step guide to calculating prorated charges.

1. Determine the Billing Cycle: Begin by establishing your billing cycle (e.g., one month, quarter, or year). Billing will often vary by company, product, and subscription plan, so multiple calculations may be required.
2. Calculate the Number of Days in the Cycle: Take your billing cycle and apply it to the customer’s actual usage. Remember that this must be done based on a calendar (varying days in a month) rather than an average.
3. Calculate the Number of Days of Actual Use: Take available information regarding the customer’s actual use of your service and compare it against the overall cycle (e.g., the customer used 20 days out of 30 on monthly billing).
4. Calculate the Daily Rate: Divide the cost of your full billing cycle by the number of days included within it to get the daily rate. For example, if you charge $30 per month (or 30 days), then your daily rate equals $1.
5. Calculate the Prorated Rate: Next, take your daily rate and multiply it by the number of days the customer actually used. For example, if they used 20 days and the daily rate is $1, they owe you $20 in prorated charges.
6. Adjust for Any Subscription Changes: If the customer made any changes to their subscription (e.g., increased/lowered)  throughout the billing period, you will need to repeat the process to get all partial costs before adding up to a total.
7. Apply Any Credit or Refunds (If Applicable): If a customer cancels a service partway through the month and has already paid for the full cycle, the prorated amount for the unused portion may be refunded or credited.

6 Common Prorated Billing Examples

As should be evident by now, proration is far more common in our everyday lives than one might think. To hammer that point home, we’ll discuss some of the most common pro rata use cases of below, complete with definitions and calculations.

#1 Pro Rata Salary

A prorated salary is a portion of the salary paid out to an employee in proportion to the number of days they’ve worked in a billing cycle, where the employment did not last the full period. This is often used in terminations and sometimes immediate hires.

When To Use It:

• Hiring/firing an employee part-way through the month
• Raising the salary of an employee during the month
• Pay-per-hour contractor salaries (contractor invoice template)
• Unpaid leave

How to Calculate:
Prorated Salary = (Annual Salary / Working Hours in the Year) x Number of Hours Worked

#2 Prorated Rent

Prorated rent is a portion of the full rent owed by a tenant to a landlord proportionate to the number of days they occupied a property, where the arrangement did not last the full period.

Download a free rental invoice template here.

When To Use It:

• Moving in/out part-way through the month
• Tenant moves out before the lease ends
• Tenant extends their stay beyond the lease

How to Calculate:
Prorated Rent = (Monthly Rent / Number of Days in the Month) x Number of Days Paid

#3 Prorated Bills & Subscriptions

Prorated bills calculate an amount owed to the provider by the user based on how long / how much of a service was used throughout the billing period. This is in contrast to standard fixed payment plans and rates.

When To Use It:

• Subscriptions/cancellations part-way through the month
• Utility bills calculated based on usage
• Rent calculated based on partial stay

How to Calculate:
Prorated Bills = (Total Billing Amount / Minimal Billing Unit) x Number of Units Used

#4 Prorated Refunds & Cancellations

Prorated refunds are necessary when a service that was previously fully utilized requires reimbursement at any point during the regular billing cycle.

When To Use It:

• Canceling prepaid annual subscriptions 
• Students withdrawing from a course

How to Calculate:
Prorated Refund = (Total Amount / Minimal Unit) x Number of Remaining Units

#5 Prorated Interest Rate

Pro rata interest rates are calculated when determining due interest from an appropriate portion of the full interest rate for a shorter time frame.

When To Use It:

• Investment products (stocks, bonds, etc.)
• Bank products (loans, mortgages, etc.)

How to Calculate:
Prorated Interest = (Total Interest Rate / Number of Months in a Year) x Number of Months in Period

#6 Pro Rata Cost Accounting

Prorated costs typically need to be calculated when allocating costs based on specific factors, such as the time period of company policy. This is often used when comparing budgets against actual purchases necessary for company production.

When To Use It:

• Evaluating company spending
• Comparing budgets to real purchases
• Allocating purchases to specific internal uses (inventory, WIP, final products, etc.)

How to Calculate:
Prorated Costs = (Inventory Costs / Total Costs) x Price Variance

Who Needs Prorated Billing?

The businesses that use proration in their regular billing and accounting can vary greatly. Some engage with the practice because it is relevant to their industry and product niches, while others are legally bound to carry out pro rata calculations. 

What Businesses Benefit from Pro Rata Billing?

Certain types of businesses find prorated billing particularly beneficial due to the nature of their services or products. Here are some examples:

• Subscription-Based Businesses: These businesses often bill customers on a recurring basis, such as monthly or annually. Proration ensures that customers are charged fairly if they join or leave a service mid-billing cycle.

Example: A streaming service offers a monthly subscription. If customers cancel halfway through the month, they only pay for the days they had access.

• SaaS (Software as a Service) Companies: Software services that offer tiered pricing or add-on features often need to adjust charges when customers upgrade, downgrade, or modify their service plan during a billing period.

Example: A project management software provider allows users to upgrade their plan mid-month. Proration ensures that they are only charged for the upgraded plan from the date of change rather than the entire month.

• Telecommunications Companies: Telecom companies frequently adjust billing when customers change their plans, add or remove services, or start/stop their service in the middle of a billing cycle.

Example: A mobile phone provider prorates the bill for customers who change their data plan mid-cycle, ensuring they only pay for the higher or lower data allowance for the days it was used.

• Utility Providers: Utility companies must prorate charges when customers move in or out of a service area partway through a billing period.

Example: An electricity provider adjusts the final bill for a customer who moves out on the 20th of the month, ensuring they only pay for the energy used up to that date.

• Property Management Companies: When tenants move in or out of rental properties mid-month, property managers use proration to calculate the rent due for the partial month.

Example: A tenant moves into an apartment on the 10th of the month. The property management company prorates the rent so the tenant only pays for the days they occupied the property.

Which Companies Are Legally Bound to Proration?

Certain industries are encouraged and legally required to implement prorated billing practices to ensure compliance with accounting standards and consumer protection laws. This most often applies to the ASC 606 set of guidelines. 

What Is ASC 606 – Revenue from Contracts with Customers?

The Accounting Standards Codification (ASC) 606 is a set of guidelines established by the Financial Accounting Standards Board (FASB) that outlines how companies must recognize revenue. 

Under ASC 606, businesses must recognize revenue when control of goods or services is transferred to the customer, which often necessitates proration when services are provided over time.

Businesses bound by ASC 606:

• Telecommunication: They must prorate revenue recognition when customers change plans or when services start or stop mid-cycle.
• SaaS Companies: These businesses must prorate their revenue according to service delivery, particularly when contracts include variable components like usage-based fees.
• Subscription Services: Companies offering subscriptions that can be started, stopped, or modified mid-term must prorate to comply with revenue recognition rules.
• Real Estate and Leasing Firms: When leases or rental agreements begin or end partway through a billing cycle, proration ensures that revenue is correctly accounted for in partial periods.
• Healthcare Providers: Hospitals and clinics that bill patients for services daily or per procedure must prorate charges based on the actual services provided.

Tips for Effective Prorating

As has been shown so far, proration can be a complex process and requires due consideration to get it right. This is especially true if you want to take advantage of all the benefits it offers without suffering its potential negative consequences. Do this:

• Clearly Define Proration Rules: Establish clear policies for how and when proration will occur. This includes defining what triggers a proration, such as upgrades, downgrades, cancellations, or mid-cycle service changes.
• Use Automated Systems: Implement automation to significantly reduce errors and save time. For example, billing platforms often offer built-in proration features to help with calculation for a comparatively nominal fee.
• Communicate with Customers: Always inform customers when proration will be applied and explain how it will affect their billing. Transparency is key to maintaining trust and avoiding disputes.
• Test Scenarios: Before rolling out proration to all customers, test the system with various scenarios to ensure it handles different situations correctly, such as mid-month changes, annual subscriptions, or usage-based billing.
• Review and Adjust Regularly: Proration is a continuous process. Review and adjust your rules and calculations regularly to ensure they align with your business needs and customer expectations.

Implementing Prorated Charges

Leaving general advice behind, let’s narrow our focus to implementing this new billing style into your operations as a business, just starting with proration. Below, you’ll find a step-by-step guide to help you on your journey. Start by:

1. Identify the Trigger for Proration: Determine the specific event that will trigger proration, such as a customer upgrading their plan, canceling a service, or changing their billing cycle.
2. Calculate the Prorated Amount: For example, if a customer changes their plan halfway through the month, divide the monthly fee by the number of days in the month and multiply by the number of days the customer used the service.
3. Adjust the Billing System: Update your billing system with the calculated prorated amount. If using an automated system, ensure that the proration rules are correctly configured to handle various scenarios.
4. Communicate the Change to the Customer: Send the customer a detailed explanation outlining the prorated charge or credit. Include information on how the proration was calculated and how it will be reflected in their next bill.
5. Monitor and Review: After implementing the change, monitor customer feedback and review billing reports to ensure that proration is being applied correctly. Make adjustments as needed.
6. Provide Customer Support: Ensure your support team is trained to handle questions related to proration. They should be able to explain the process clearly and resolve any issues that may arise.

Alternatives to Proration

Although proration is a common practice in many industries and businesses, some companies may not have the resources to implement it into their billing processes or may just be unwilling to do so. If that’s your case, you can consider these alternatives:

• Flat-Rate Billing: Charge customers a flat rate regardless of when they start or stop using the service. This is simple and easy to manage and delivers predictable revenue, but it may lead to customer dissatisfaction.
• Rolling Billing Cycles: Start a new billing cycle whenever a customer signs up or changes their plan. This aligns billing cycles with customer activity, removing the need for proration but can complicate accounting and forecasting.
• Credit System: Offer customers credits for partial periods or unused services. These credits can be applied to future bills. This provides flexibility and a sense of fairness but requires racking credits and may delay revenue recognition.
• Usage-Based Billing: Bill customers based on actual usage rather than a fixed rate, eliminating the need for proration. This is fair and transparent but may be difficult to implement for all types of services.
• Discounts or Incentives: Offer discounts or incentives for customers who commit to full billing cycles, even if they start mid-period. This can encourage long-term commitment and reduce churn but turn away short-term clients.

Technology in Prorated Billing

However, you don’t necessarily need to seek a proration alternative if your main concern is the associated workload. Thanks to the sophisticated state of the third-party software market, there are tools for almost every use case. You can save time and effort with:

• Automated Billing Systems: Modern billing platforms like Billdu offer advanced invoicing capabilities and can sometimes even feature automatic calculations of prorated charges based on predefined rules.
• Integration with CRM and ERP Systems: Maintain a comprehensive view of customer activity and financial performance by integrating your system with CRM and ERP platforms to simplify process evaluation and reporting.
• Real-Time Proration Calculators: Calculate your own billing or give your customers the ability to do so by using free online real-time proration calculators, or implementing one on your website.
• Data Analytics and Reporting: Keep track of your performance and customer account status by leveraging advanced analytics tools with automation and reporting features to help optimize processes, and improve decision-making.

Conclusion: Transform Your Billing with Billdu

Proration can be tricky. But it doesn’t have to be with Billdu. Our simple-to-use software allows you to create custom templates and make invoicing an absolute breeze.

Want to charge a customer a prorated bill for their subscription? 

Just set their basic pricing unit as an hour/day with the appropriate amount and calculate how much they owe you right in the invoice by inputting their actual use this billing cycle. 

Want to keep a closer eye on costs?

Leverage our expenses record feature to keep an eye on your spending, and combine that with our inventory tracker to ensure operations keep on running smoothly.

Don’t want to do all of this yourself?

Billdu allows you to onboard multiple users and connect with an accountant under the same profile, letting you focus on your business while the finance team does its thing.

And did we mention you can do all of this for 30 days completely free? Just sign up, choose the subscription plan you want to try and get started immediately! It really is as simple.

Unlock the Full Potential of Billdu!

Boost your business with Billdu’s powerful invoicing features, from quick invoice creation to automated payment reminders. Start using Billdu now!