It’s unlikely that an organization’s customers will start, change, or terminate their subscriptions at the beginning of a billing cycle. And organizations with usage-based pricing need to ensure that customers aren’t overcharged for services they haven’t used.
Proration is a method that organizations use to ensure their customers are billed fairly for the services they’ve used.
What is Proration?
Proration is a method of calculating the cost for partial use of any product or service. It’s used in business transactions to calculate an amount based on what portion of the payment period was used.
For example, if a customer subscribes to a monthly subscription service on July 15 and billing happens on the first of each month, proration will calculate the cost for the 15 days that have been used instead of charging the full amount for 30 days.
In the case of usage-based billing (e.g., usage-based pricing for a telco or public utility), the billing organization will monitor the usage for the partial month and the following month and then prorate the cost for the customer based on those usage figures.
The purposes of proration include:
- Ensuring customers are billed fairly for the goods and services they’ve used.
- Simplifying billing processes by automating calculations of partial use.
- Minimizing errors that arise from manual calculations.
This type of pricing is typically used by Software-as-a-Service (SaaS) companies, telcos, streaming services, and other businesses using a recurring revenue model.
Allowing customers to pay prorated amounts results in higher customer retention rates, improved conversion rates, and an overall better customer experience.
- Prorated Payment: A payment that is calculated based on the amount of time a customer has used a product or service in a single accounting period.
- Prorated Invoice: An invoice that includes a prorated payment for goods or services used in part of a billing cycle.
- Proration in Billing: The process of calculating a payment amount for the goods or services used during part of a billing cycle.
At its core, calculating the proration factor is simple—take the total amount of the product or service used and divide it by the total number of days in the billing cycle.
But it requires time and effort to manually calculate prorations for each customer. Billing teams need to pay attention to the proration period and use the two-part formula described above to calculate the amount.
The proration period is the length of time between the start of a subscription and its first applicable billing cycle.
For example, if a customer starts using a subscription-based product on July 15 and billing cycles are monthly (30 days) then they will have used 15 days worth of services.
The formula for calculating proration is as follows:
(Total Amount Used ÷ Total Number of Days) × Proration Period = Prorated Payment
In the example above, the total amount used would be 15 days. The total number of days in a month would be 30. And the proration period is 15 days.
The cost for this partial use is calculated by dividing the total cost of the product or service (e.g., $100) by 30 days, then multiplying it by 15 days:
(100 ÷ 30) x 15 = $50
This means the customer should be billed $50 for the services used in a partial month instead of the full amount ($100).
Proration and CPQ (Configure-Price-Quote) and Billing
CPQ software helps organizations automate their quoting, pricing, product configuration, and ordering processes. It eliminates the need for manual calculations, which reduces errors in billing and ensures customers are billed accurately for the goods and services they use.
When generating quotes and invoices, CPQ systems automatically calculate the proration factor for each customer based on the billing cycle. This helps streamline billing operations and ensures customers are billed fairly for the goods and services they use.
This is done using a prorate multiplier, which is the fraction of the billing cycle that a customer has used. The multiplier is then applied to the total cost of goods and services in order to calculate the correct prorated payment amount.
CPQ platforms can also identify different proration types (e.g., partial month, partial year) and adjust the multiplier accordingly. This helps organizations ensure accurate billing for each customer regardless of when their subscription began or ended.
People Also Ask
What are the two types of proration?
Proration means different things in different contexts. For example, it can refer to the process of calculating a payment amount for goods or services used during part of a billing cycle. It can also be used to describe the process of adjusting payments due or owed based on usage over a given period.
In subscription billing, there are two main types of prorations: partial month and partial year.
Partial month proration takes the total number of days used during a billing cycle and divides it by the total number of days in that cycle—resulting in a fraction that is then multiplied against the total cost of goods or services to calculate the correct amount owed or due.
Partial year proration is similar, but it considers the number of days used during a full year instead of a single billing cycle. This helps organizations determine the amount owed or due for services used over the course of an entire year.
What is prorated payment?
A prorated payment is the amount a customer pays or is owed for goods or services used during part of the current billing period. It is calculated using a two-part formula, which considers the number of days used and the total cost of goods or services. The resulting payment amount reflects only the portion of the total cost that applies to the usage period.
What is an example of proration?
An example of proration would be a customer who signs up for a monthly subscription with only a week left to go in the month. The customer would only be billed for the week of usage, and not the full month. This is done by calculating a fraction of the total cost (based on the number of days used) and multiplying it against the total cost to arrive at a prorated payment amount.
In this example, if we assume a subscription fee of $100 and seven days left in the month, the customer would be billed $14.29 (7/30 x 100). This amount reflects only the portion of the total cost that applies to their usage period and ensures they are not overcharged for services they did not use.
Why does proration happen?
Proration happens as a way to ensure fairness between customers and to accurately calculate the amount owed or due for goods or services used during a partial billing period.
From a customer standpoint, proration allows them to be billed accurately for the goods and services they use.
From a business standpoint, it streamlines billing operations, improves customer retention, and reduces the cost of customer acquisition.