What is a Prorated Charge? - How to Do Prorated Billing

Last Updated on July 18, 2023 by Labib Ahmad

What is prorated billing?

The term "prorated" or "prorate" stems from the Latin pro rata which roughly translates as "in proportion to" in English.

The prorated billing model is a way to calculate bills or invoices based on the daily cost or the portion of a subscription service used. It's a helpful tool when it comes to streamlining your invoicing software for your small business. It means that customers are only charged for the number of days they actually use the service. 

Using prorated billing ensures and simplifies the process of determining partial billing charges for your customers. This can be especially helpful for subscription businesses, for example, if you offer services on a monthly basis and have customers who make changes to or cancel their accounts partway through their billing cycle. In these cases, using prorated billing can help keep payments fair for your customers and your business.

How prorated billing works

Because prorated billing calculates the bill based on the percentage of the month that the service was used by the customer, if any changes are made to the subscription plan, or if the customer cancels their subscription plans altogether, prorated billing will adjust their final bill to be proportional to what the customer should pay. You do not need to worry about customers becoming upset about being overcharged or your revenue stream taking a hit due to mid-month cancellations.

In simple terms, prorated charges enable customers to pay only for the specific amount of the service they have used. This ensures accurate billing, where any changes to the subscription service are precisely reflected in the prorated bill amount, resulting in fair and proportional charges for customers. With prorated billing, you can alleviate worries about customer dissatisfaction due to overcharging and minimize revenue loss for your business.

Example of prorated billing and how its calculated

If a customer signs up for a subscription plan on June 12th, and your billing model is set to charge new customers on the 1st of the next month, they will only be billed for 18 days of the service they use in June. Then, on the first of the following month, July 1st, the customer will be charged for the full 30 days of expected usage because they are now in sync with the billing cycle.

Similarly, if the customer cancels their subscription plan, for example, on September 8th, they will be charged for just the 8 days they used the service.

In review, if a new customer signs up halfway through a given month, they will only be billed for the portion of the month that they were your customer.

How are prorated charges calculated?

Prorated charges are calculated by assessing the amount owed by customers for the time (number of days) they used your services. 

Here is how to calculate that amount:

1. Take the monthly price of your subscription service and divide it by the number of days in the month. This will give you the daily charge amount for the service.
2. Take the daily charge amount and multiply it by the number of days the service was used. This should output an amount that is exactly in proportion to the service the customer has used.

To get the most out of a prorating model, be sure to check out a payment provider that offers the best invoice software with automated prorated billing for your business. This removes manual calculations and human error from your billing system to ensure both you and your customers are getting the most out of it.

Why should merchants use prorated billing?

If your business does not have a prorated billing model and a customer cancels their plan at the beginning of the month, then your business will be overcharging the customer for services they did not use. This is not ideal, as it can cause an increase in customer complaints, disputes, and hurt your brand image. Without a prorated billing model, you can opt to give customers a partial refund, or refund them their entire monthly fee. In either case, your business will be losing out on revenue.

For example, if a customer has a monthly plan that renews on the 1st of each month but they cancel their plan on the 6th, by refunding them the full monthly fee, your business loses out on six days of revenue. If this were to become a regular occurrence, then your business may lose out on a significant amount of dollars as per services rendered.

This is where prorated billing is really effective. By switching to a prorated billing model, your business can enhance customer satisfaction, reduce potential disputes, enhance brand image and loyalty, and most importantly, give your business a competitive advantage over businesses that do not offer prorated billing on their invoices.

When should you prorate a customer’s bill?

You want to ensure you're only charging customers for the time (number of days) they used your services. Some examples of when you would use prorated billing include:

• Consolidating subscription payments onto the 1st of every month
• When customers upgrade or downgrade their plans
• Mid-month plan cancellations or activations

Final thoughts

By implementing prorated billing for your business, you will charge your customers fairly for the services they receive, whilst keeping your revenue stream intact. A prorated billing model keeps customers happy and your business thriving!

FAQs

Are refunds the same thing as prorated charges?

Prorated billing and charges are different from a refund. A refund is simply money returned to the customer for a service or product. Prorated billing removes the process of refunds altogether because the merchant is only charging the customers for the service they have used.

Does prorated billing work with yearly subscriptions?

Yes. An annual prorated bill is very similar to a monthly prorated bill. The only difference is instead of dividing the monthly price of the subscription by the number of days in the month, the merchant takes the yearly price of the subscriptions and divides it by 365 instead.

Does prorated billing work with automatic payments?

Yes, prorated billing should work with automatic payments. However it is important to check with the specific subscription service you plan to set up automatic payments for. Some automatic payments may pull the full amount for the monthly subscription even if you cancel the subscription in the middle of a billing period.

What type of businesses is prorated billing suited for?

Prorated billing is best suited for subscription businesses that charge their customers monthly. A lot of Software as a Service businesses (SaaS) utilize prorated billing because they allow for changes to subscription plans at any time, for example, cancellation, upgrading, downgrading, etc.