One thing that often annoys the customers in subscription-based services is when they want to upgrade or downgrade a plan or quit the service after using it for a short period and end up paying the full fee for the selected plan. They end up paying the full bill despite not using the service for the entire billing cycle.
Proration refers to the system of charging the customer only for the period they have used the service or product. The type of billing system is relevant to SaaS and subscription model businesses.
What are prorated charges?
The definition of the word prorated is “according to the calculated share.” Prorated charges can be defined as the adjusted invoice or bill calculated per the customer's usage. For example, if you subscribe to a cell phone plan that has a 30-day billing cycle and you end the service mid-month, you would be charged for 15 days only or half the price.
Businesses and startups (especially subscription-based businesses) can use prorated charges to ensure their customers are only charged for their services. For example, a business could prorate charges for a subscription service, so if they unsubscribe from the service mid-month, they should be charged accordingly. This can be helpful for companies that offer monthly subscriptions or other services with recurring charges.
Prorated charges can help businesses retain their customers and increase revenue by providing a fair and accurate billing practice for partial periods of use. This can help to prevent customer dissatisfaction and potential loss of business due to overcharging or undercharging for services or products.
For example, let's say a customer cancels a monthly subscription service halfway through the month. With prorated charges, a business can only charge the customer for the number of days or units of service they actually used during the partial period. This ensures that the customer is only charged for what they actually used, rather than the full monthly fee, which can help prevent upset customers and potential loss of business.
Why do you need prorated charges for your business?
Increase customer retention
Prorated charges can be a great way for businesses to increase revenue because they allow the business to charge customers for only the portion of a service or product that they use. This can be especially beneficial for businesses that offer services or products that are used on a recurring basis, such as subscription-based services or rental properties.
It allows customers to change their subscription, whenever they want without waiting for the billing cycle.
For example, if a business offers monthly subscription-based services and a customer signs up in the middle of the month, the business can use prorated charges to charge the customer only for the remaining days in the month, rather than the full monthly fee. This can be a win-win situation for both the business and the customer, as the business is able to retain its customer, and the customer is only paying for the days they actually use the service.
Are there any drawbacks to using prorated charges for customers?
There are a few potential drawbacks to using prorated charges for customers.
Calculating prorated charges can be a real pain.
It requires accurately figuring out the total charge for the full period, the number of days or units used in the partial period, and applying the appropriate calculation to the customer's bill. This can be a tedious and error-prone process, especially for businesses with a lot of customers or a wide range of products and services.
Prorated charges can sometimes result in unexpected or confusing charges for customers.
For example, let's say a customer switches from a monthly subscription service to an annual subscription service halfway through the month. In this case, they may be charged a prorated fee for the remainder of the month, in addition to the full annual fee for the new subscription. This can be confusing or surprising for customers, and may cause dissatisfaction or frustration as they have paid more than their expected usage.
In short, while prorated charges can provide a fair and accurate billing practice for partial periods of use, there are potential drawbacks to using them. These include the complexity and time-consuming nature of the calculations, and the potential for confusing or unexpected charges for customers.
How are prorated charges calculated?
Here's the basic rundown using your business as an example:
- Determine the total charge for the full period. For example, if you're calculating prorated charges for a monthly subscription service, this would be the total monthly fee for the service.
- Determine the number of days or units used in the partial period. For example, if a customer starts using the subscription service halfway through the month, this would be the number of days or units of the service they will use during that month.
- Apply the appropriate prorated charge calculation. This typically involves dividing the total charge for the full period by the number of days or units in the full period, and then multiplying that number by the number of days or units used in the partial period.
So, for example, let's say the monthly subscription fee for your service is $100, and a customer starts using it on the 15th of the month. The total number of days in the month is 30, and the customer will use the service for the remaining 15 days. To calculate the prorated fee, we would divide $100 by 30 to get a daily rate of $3.33, and then multiply that number by 15 to get a prorated fee of $49.95 for the partial period.
Of course, the exact calculation will vary depending on the specific circumstances, but this is the basic process for determining prorated charges.
Failing to understand exactly how prorated charges are calculated can lead to inaccurate billing, resulting in overcharging or undercharging your customer. Which may require you to issue prorated credit or chase the customer for payment.
Small businesses can use prorated charges to charge customers according to customer's use of their product or service. It's a great way to encourage loyalty and increase customer retention.