What is a prorated charge? Learn more about prorated charges, how they can support your business, and how to incorporate them in payment processing.
In many cases, but certainly not all, businesses only need to worry about discrete payments. In other words, a retailer or similar business charges a customer based on the price of the goods they purchase. It’s a simple model that works well across a wide range of industries.
However, these distinct and individual payments don’t always make sense for customers or businesses. For companies that offer continuing access to services instead of products, regular billing cycles are a much better fit.
Depending on when a customer joins or leaves, prorated charges may be needed to fully collect revenue and avoid overcharging clients. A prorated bill ensures that customers are only charged for the time they use the service, maintaining accurate billing and customer satisfaction.
Keep reading to learn more about prorated charges. We’ll start with a closer look at the rationale behind prorated charges. Then, we’ll define exactly what a prorated charge is and discuss use cases.
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Proration is a billing method that ensures customers are charged fairly and accurately for the services they use. It adjusts the cost of a service to reflect only the price of what is actually used. This method is particularly crucial for subscription-based businesses, as customers often change or cancel their subscription plans at various points during a billing cycle. By using proration, businesses can avoid overcharging or undercharging their customers, thereby maintaining a fair and transparent billing process.
The term “proration” originates from the Latin phrase “pro rata,” which translates to “in proportion to.” In practical terms, proration is a method of calculating the cost of a service based on the time it is used. This ensures that customers are only charged for the portion of the service they actually utilize. Proration is commonly employed in subscription-based businesses, such as software as a service (SaaS) and streaming content services, where customers may join or leave at different times within a billing cycle.
A prorated charge is a fee calculated for a partial billing period, ensuring that customers are billed fairly for the time they use a service. For instance, if a customer subscribes to a service halfway through a billing period, they would only be charged for the remaining days of that period. This approach is essential in prorated billing, as it aligns the charges with the actual usage of the service. Prorated charges are a key component in maintaining fairness and accuracy in billing, especially in subscription-based models.
Consider a business that delivers software as a service (SaaS) to its customers. Let’s say this company offers a business management tool, like a platform to track and manage sales opportunities. However, the offering could potentially be anything from an ongoing gym membership to access to a streaming content service.
Delivering a service is much different than providing a product. SaaS and many other services are designed around continuing access in exchange for regular payments. That’s not a use case where a one-time payment for an individual product (or cart full of them) applies.
Instead, recurring payments are generally used, with a payment made for each period of service. This could be any mutually agreed-upon period of time but is frequently set on a monthly or 30-day cadence. One month of service is billed at a monthly or 30-day rate for as long as the customer uses that service.
What happens in these situations when customers don’t use a full month of service? What if a customer needs to cancel because of budget constraints before coming back? What if they rejoin later on, midway through another month?
This is where prorated charges can provide value for both customers and companies. Instead of charging a customer for the full billing cycle, businesses can apply a prorated fee based on their use that month.
For businesses, that means capturing owed revenue without going overboard. For customers, it means a cost in line with the actual availability and use of the service that month. Ultimately, that can mean a better customer experience.
If you're a business owner, you likely already understand what a charge is in general. Just to be clear, a charge is the payment a business requests in exchange for goods or services.
Prorate is a verb based on the Latin term "pro rata." Pro rata itself translates on a practical level to "in proportion," as Investopedia explains.
It's often applied to situations where a service or good is distributed based on each customer or user's fair share. That fair share may be based on the amount or time period across which a service is used. Pro rata distributions can also apply to investment dividends and insurance policies, among many other scenarios.
The meaning of prorated charges: A prorated charge can be seen as a charge based on the proportion of the whole used by an individual customer. The client only pays the prorated amount of the service actually used.
For example, charging a client based on the number of days in which they've subscribed and used a SaaS service across a 30-day or monthly subscription cycle. A client who signs up at the 15-day mark of that cycle would be charged half (or roughly half in a true monthly cycle) of the full price.
Prorated billing works because it takes a more individualized approach to each client. Instead of billing all customers the full charge for a subscription plan regardless of the circumstances, prorating allows for a more adaptive and relevant approach.
Prorated fees help businesses get their fair share of payment when a customer joins in the middle of a billing cycle or at any point besides the beginning of that cycle. Then, the customer will pay the full amount going forward.
If a customer ends their subscription during another billing period in the future, that charge can, and likely should, also be prorated. It's the same foundational concept: Only charging customers for what they actually use.
Similar use cases exist when customers upgrade a subscription service or downgrade their plans. Prorating charges in line with when clients make such a change more accurately reflects their use of the service and the benefits they can gain from it.
Some billing systems can offer the opportunity to adjust in real-time to issue a prorated charge each month. Others may apply a prorated credit to the customer's next bill. In both situations, the customer's charges ultimately reflect their individual use, or lack of opportunity to use, either the service as a whole or certain features of it.
Prorated charges are one of many potential functions in billing and credit card processing that a business may need to use. While it's not an especially difficult concept in terms of processing payments, ensuring your service providers can capably handle such payments is crucial.
Swipesum helps companies just like yours find the most relevant and effective merchant services providers and credit card processing solutions for their unique needs. We'll handle the comparative research, make informed suggestions, and help with negotiating and reducing a variety of fees. Best of all, it comes at no additional cost to your business.
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