Every business needs to keep an eye on its money to stay healthy. While some businesses get paid once for a product or service, others, like many software companies, earn money through subscriptions.
In a subscription setup, customers pay every month to use a service and get its full benefits throughout that month. But the problem with the subscription-based model lies is, occasionally, customers cancel their subscriptions in the middle of a billing period. What can businesses do? Can companies make customers pay for the total period that they had signed up for or charge them precisely for the services that have been used?
Here is when the prorated billing comes into play. With the help of prorated billing, you are ensured that your customers are being charged accurately and fairly.
Prorated billing refers to the practice of charging customers for the duration they have utilized a product or service. This billing approach is especially relevant for businesses that operate on a subscription-based or software-as-a-service (SaaS) model. In a subscription-based model, both orders and revenue streams occur on a recurring basis. When customers subscribe to a service they agree to pay a predetermined amount at intervals in exchange for using the products or services.
The actual billing amount depends on the plan the customer has subscribed to and the overall duration of their subscription. Typically customers remain subscribed to the plan and make recurring payments accordingly. However, complications can arise when customers decide to modify their plans or switch them prior, to their billing renewal date.
In such situations the billing amount is calculated based on the number of days spent under each specific plan – this is known as prorated billing.
Prorated billing is a system that determines the amount you should pay for a service based on the time you use it. It allows you to be charged for the days or hours that you utilize the service rather than paying a fixed monthly or yearly fee regardless of usage.
This billing method is commonly used by businesses operating on a subscription model. These companies generate revenue through yearly or monthly subscriptions and provide customers with the flexibility to modify their subscription plans more frequently, than just once a year. The advantage of prorated billing for customers is evident; it ensures that you only pay for the duration you use the service rather than being committed to a full-year payment when you may only need the service for a few months or even just a few days. This approach to billing promotes fairness and flexibility empowering customers to have control, over their expenses and get value from their subscriptions.
A subscription billing business, or SaaS subscription provider, might use prorated billing in the following scenarios:
Sometimes customers who have already subscribed to a plan may choose to switch to a plan that offers more advantages has a different price or includes additional features. When a company providing subscription services allows its customers to easily make this switch it needs a way to determine the payment for the customer during the transition.
This is where prorated billing becomes relevant. Essentially prorated billing helps calculate the proportion of the plan’s cost that the customer should pay based on how much time remains in their billing cycle. Let us say we have Linda as an example; she has been subscribed to the plan of a streaming service for $100 per month. However, through the month, she decides she wants to upgrade her subscription to the premium plan which costs $300 per month. Here’s how it works:
| Step | Description | Calculation | Result |
| Calculate Daily Cost | Determine the daily cost of each plan. | Basic Plan: $10 ÷ 30 days | $3.33/day |
| Premium Plan: $300 ÷ 30 days | $10/day | ||
| Determine Partial Usage | Identify the portion of the month Linda used each plan. | Days on Basic Plan: 15 days | 15 days |
| Days on Premium Plan: 15 days | 15 days | ||
| Calculate Prorated Cost | Multiply the daily rate by the number of days for each plan. | Prorated Basic Plan Cost: $3.33 × 15 days | $49.95 |
| Prorated Premium Plan Cost: $10 × 15 days | $150 | ||
| Total Cost | Add the prorated costs of both plans to get the total amount owed by Linda . | Total Cost: $49.95 (Basic) + $150 (Premium) | $199.95 |
Without prorated billing Linda would have had to pay the $300 for switching to the premium plan even though she only used the basic plan for half of that month. However, thanks to prorated billing mechanisms in place companies can calculate Linda’s payment based on how much time she will utilize and benefit from having access, to the premium plan during that particular month.
Rather than upgrading, your customer will switch to a lower plan. The calculation method remains the same. However, in this case, instead of asking the customer to pay an additional amount right away, you’ll need to adjust a credit that they already have against the cost of the new, lower-priced plan. This credit will then be applied to their next bill. To make this clearer, let’s walk through a detailed example.
A customer, let’s take Linda from the previous example, was previously on a higher-tier plan that costs $150 per month. Midway through the month, she decides to switch to a lower-tier plan that costs $100 per month, this is how it will look like:
| Step | Description | Calculation | Result |
| Calculate Daily Cost for Higher Tier Plan | Determine the daily cost of the higher-tier plan. | Daily Cost: $150 ÷ 30 days | $5/day |
| Determine Unused Days in Higher Tier Plan | Identify the number of days John didn’t use the higher-tier plan. | Unused Days: 15 days (half of the month) | 15 days |
| Calculate Credit Amount for Unused Days | Multiply the daily cost by the number of unused days. | Credit Amount: $5/day × 15 days | $75 |
| Calculate Daily Cost for Lower Tier Plan | Determine the daily cost of the lower-tier plan. | Daily Cost: $100 ÷ 30 days | $3.33/day |
| Calculate Deduction from Credit | Multiply the daily cost of the lower-tier plan by the number of remaining days. | Deduction: $3.33/day × 15 days | $49.95 |
| Adjust Remaining Credit | Subtract the deduction from the total credit amount. | Remaining Credit: $75 – $49.95 | $25.05 |
| Carry Over Excess Amount | The remaining credit of $25.05 will be adjusted in the next month’s billing. | Adjusted Credit for Next Month | $25.05 |
Linda will be credited $75 for the portion of her higher-tier plan that she did not use. After deducting the prorated cost of the lower tier plan for the remaining days, any excess credit of $25.05 will be carried over and applied to adjust their billing in the month.
This ensures that the customer receives an adjustment for the days they did not use without losing out on the credit amount.
Many businesses can gain from using prorated billing, especially when customers change or start subscriptions partway through a billing period. Here’s a closer look at the kinds of businesses that find prorated billing useful:
Companies like streaming platforms, software services (known as SaaS), fitness clubs with memberships, and other subscription services can all use prorated billing. This method lets customers adjust or start their subscriptions at any time during the billing cycle, making it easier for them and increasing satisfaction.
Professionals like consultants and freelancers, as well as utility companies and car rentals, can also benefit from prorated billing. By charging customers only for the time or amount they actually use, these businesses can keep billing clear and build trust with their customers.
Places like co-working offices, hotels, and event halls often use prorated billing. This lets them adjust charges based on the time or space you use. It’s handy when bookings change and helps them manage money better.
Companies that offer things like internet access or online storage can use prorated billing too. This lets customers change plans or services without extra fees, making them more likely to stick around and trust the company.
Groups like clubs or professional organizations can also use prorated billing. It lets members join or renew anytime during the billing period. This makes things easier for everyone and helps them collect fees more accurately.
Proration is only sometimes straightforward. In some scenarios, with upgrades, feature removals, and early terminations, the calculations can be complex, especially when there are multiple operations per customer. Here are some tips for prorated subscription billing:
As most SaaS products enable customers to make changes to their subscription plans within a billing cycle, it is crucial to have the capability to align fees with actual usage. In this manner, the customers are assured that they have only paid for the services they use. It is an excellent way to boost customer engagement and loyalty and encourage referrals.
Prorated billing is an excellent way to handle subscription changes. However, doing the calculation manually is time-consuming. Switching to a professional subscription management software solution for calculating prorated billing can help save time significantly. It can also help in preventing expensive errors.
Customer success plays a crucial role in the failure or success of any SaaS business. Therefore, knowing how to prorate can have a significant impact on the success of the company.
Proration is crucial in streamlining accounts’ billing, invoicing, and payment processing without the hassles of refunds, chargebacks, or adjustments.
Using prorated billing can be tricky for businesses. Here are some key issues they might face:
Integrating a billing system into your small business can bring about fairness and transparency benefiting both you as the service provider and your customers. Here are some suggestions, on how to incorporate prorated billing into your operations;
Prorated billing emerges as a pivotal solution for businesses and customers alike, offering a balanced approach to subscription management. This billing method stands out for its fairness, ensuring that customers are only charged for the services they actually use. For businesses, prorated billing streamlines operations by automating calculations and minimizing administrative complexities.
While its advantages include trust-building, accurate billing, and simplified processes, there are also challenges to consider, such as system development and potential customer confusion. Nonetheless, with careful implementation and transparent communication, prorated billing can significantly enhance the customer experience, build loyalty, and contribute to the overall success of subscription-based businesses.
To prorate means to allocate or divide something proportionally based on a specific time frame.
Proration might sound intricate, but it’s quite straightforward. Imagine you rent a service or product for a shorter duration than initially planned. In that case, it’s reasonable to pay only for the time you utilized. That’s the essence of proration—adjusting costs based on actual usage.
Calculating prorated charges involves a simple two-step process:u003cbru003eFirst, determine the daily rate by dividing the monthly fee by 30.u003cbru003eNext, multiply this daily rate by the number of days the service was used to arrive at the prorated amount.
The prorated formula is straightforward: Divide the specific quantity of an item by its total available quantity. This resulting ratio can then be applied universally to other related items to maintain the same proportion.
