What Do You Mean By Prorated Billing & How It Works?

What Is Prorated Billing?

Prorated billing is a billing method that adjusts the price in order to match what actually has been used. As its name suggests, it allows businesses to prorate a bill so that customers can pay for services they have used and not for the entire billing period.

Implementing prorated billing means the amount to be paid by customers is only for what services they have used, it can’t be more or less. Although prorated billing brings somewhat more work for businesses, it is still worthwhile because your customers will be more than satisfied, ultimately improving business credibility.

Who Needs Prorated Billing?

Any businesses that offer subscription-based pricing for their products need prorated billing, regardless of business size and structure. Even if your business is privately held or public, you need a prorated billing method to manage prorated credit to make sure clients only pay for what they have used without impacting your business revenue.

Subscription-based companies are required to conduct fair financial reporting practices in order to stay compliant with ASC 606 (A part of GAAP). That’s where prorated billing comes in. It ensures you comply with this accounting principle by charging fairly based on the actual service usage.

When Should Prorated Billing Be Used?

Prorated billing can be implemented if any of your customers want to switch to higher plans in the ongoing billing cycle. So, if the customer wishes to upgrade or downgrade their active subscription plan, you need to issue a prorated invoice, adjusting the cost as per actual usage. So, any users willing to change their active plan amid the ongoing billing cycle can lead to prorated charges, prompting companies to use prorated billing methods.

For example, let’s say you are running a SaaS company, offering subscription-based pricing for your live streaming services. One of your subscribed users asks you to cancel their active plan in the middle of the current billing cycle. At this point, you need to use prorated billing to adjust the due amount as per usage. In this scenario, you need to prioritize prorated billing over the standard billing process, which often overcharges users.

How Prorated Billing Works?

The prorated billing process works on several factors such as the number of days, the cost of each plan, and your billing cycle. So, you need to check the date when the customer switched to the other plan and the previously active plan. Then, you can determine the days left in a particular month, including new applicable rates.

SaaS companies usually have a 30-day billing cycle, in which you can include the number of days the customer used the old plan and the number of days the customer used the new plan. By doing so, you can find prorated charges incurred during a billing cycle. This is how prorated billing demands payment only for the services the customer used, not more or less than that.

How to Calculate Prorated Charges

Let us take an example to help you understand prorated charges calculations.

Imagine you own a subscription-based company with multiple plans for users to access live-streaming music. A user currently active on the basic plan, priced at $25/month, decides to upgrade to the higher plan, priced at $100/month.

The billing cycle starts on the 7th of each month, but the customer asked to change the plan on the 20th of Oct. So, now you need to account for 13 days of the base plan (7th Oct to 19th Oct) and 18 days of the higher plan (20th Oct to 6th Nov). Below is the detailed calculation.

$25 ÷ 31 days = $0.81/day
$100 ÷ 31 days = $3.23/day

For the basic plan: $0.81 × 13 = $10.53
For the higher plan: $3.23 × 18 = $58.14

As a result, prorated charges would be $10.53 + $58.14 = $68.67.

Importance of Prorated Billing

Here are some of the benefits companies can expect by implementing a prorated billing process.

1. Easy Upselling

Companies adopting a prorated billing process will find it easier to inspire customers to upgrade their subscription plans, ultimately driving more sales and revenue. Your active users will happily switch to higher plans knowing they don’t need to pay extra for unused services.

2. Flexibility

With a prorated billing process, your users get unmatched flexibility to change their active plans. They can downgrade or upgrade their plan as per their needs in the ongoing billing cycle. Prorated billing will ensure they only pay for what has been actually used.

3. Accurate Billing

Companies using a prorated billing process to manage users’ outstanding amounts can make accurate bills. They can only charge for the service that has been used by the user, not more or less than that. Companies can generate highly accurate bills even if the user has changed the plan.

4. Delights Customers

Prorated billing only takes money for actual service usage and not for unused service, making customers satisfied with incurred costs. Even if someone has canceled their plan in between the billing cycle, companies can not charge for the remaining days. This way, it enhances customer satisfaction.

Conclusion

Prorated billing ensures accurate payment collection from customers, regardless of their current plan’s validity. The process is widely adopted by subscription-based companies to enhance customer satisfaction and maintain steady cash flow. If not manually, you can accelerate prorated billing using automation software like Moon Invoice.

The sophisticated invoicing software plays a vital role in creating a professional and accurate invoice, which neither needs frequent revision nor manual calculation. Try generating a prorated bill using Moon Invoice for free.

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