What is Proration?

Proration Isn’t Rocket Science, Just Smart Billing

Proration can be boiled down to a simple use case:

"If a group of customers use Plan A for 20 days and switch to Plan B for the next 10 days (assuming that a billing cycle lasts 30 days), they should be charged Plan A prices for two-thirds of the month and Plan B prices for the other one-third."

As you can see, it’s a way to ensure that they are charged accurately for the portion of the services they’ve used, taking into account their actions (upgrades /downgrades) to change the quantity/subscription terms of these services before a billing cycle ends.

Now consider two simple sub-use cases:

Proration with Upgrades

When a subscription is upgraded, calculate the amount for the remaining period of the new plan and add that as a line item to the invoice generated during the plan change.

Current Plan: $100 / month

New plan: $150 / month

Proration logic:

• $100 paid at the beginning of the billing cycle.

• Assume, changes are made exactly in the middle of the billing cycle.

• Prorated “consumed” charge $50.

• Prorated credit remaining is $50.

• Additional charge on new plan for the remaining period: $75

• Net additional charges after adjusting credits: $25

Proration with Downgrades

When a subscription is downgraded, the customer is more likely to have paid more than the expected usage in the middle of the billing cycle. There will be a net credit to the customer. This needs to reflect unambiguously in the invoice line items, with appropriate charges.

Current Plan: $150 / month

New Plan: $100 / month

Proration Logic:

• $150 paid at the beginning of the billing cycle

• Assume, changes are made exactly in the middle of the billing cycle.

• Prorated “consumed” charge $75

• Prorated credit remaining is $75

• The charge on the new plan for the remaining period: $50

Net additional credits after adjusting credits: $25.

Here is what the next bill would look like:

Chargebee takes one more important factor into account when it prorates charges: the state of the invoice (paid or unpaid). The more factors that go into your logic, the more complex prorating gets. But good proration intelligence provides options for as many relevant factors as possible.

Is Proration Necessary?

If you’re just starting out, it may seem like too much effort to set up proration. Why not just remove the option to switch plans mid-cycle and set up non-prorated billing? Several businesses do choose to go with this. But while it seems deceptively simple and hassle-free in the beginning, you’ll quickly realize that it’s ill-equipped to deal with some basic challenges like:

• Mismatched Invoicing & Billing Cycles - Businesses who are your customers may want to be billed on a specific date because your invoicing cycle doesn’t sync with their billing cycle. For instance, Neil Patel says it’s good to let customers pick their own date and even suggests adding a line somewhere in the checkout process that reads "Need a different billing date? Send us an email, and we’ll see what we can do!" Proration helps you send clear, unambiguous invoices when you go the extra mile to provide billing flexibility for your customers.

• Fair Usage-Based Charges - Without proration, you have to charge more than a customer consumes if they want to downgrade or keep them stuck on an old plan if they want to upgrade, until the next billing cycle. In the first case, the customer will feel like they’re being overcharged unfairly without options for a refund, and in the second, you’re losing out on revenue. Neither is good for you or your customers.

To sum it up, proration is the smartest way to balance clean & clear bookkeeping on your end and provide convenient billing options on the customer end. And while you can leave it out of the mix if you want, you’re really going to miss it when your customer base grows.

Pro Tip: How can you refund customers who are downgrading their plans mid-cycle?

You can simply refund the outstanding amount in the next invoice. But this doesn’t let you calculate the reduction in your tax liability or document the downgrade for reference. And what do you do when the invoice hasn’t been paid yet? You can’t return the money you never received.

Instead, efficient billing systems use something akin to credit notes (you may be familiar with the term if you’ve used accounting software). A credit note is an invoice-like document that either assigns refundable credits for the equivalent of the money owed to the customer or directly adjusts the invoice amount to reflect the downgrade. It’s neat, unambiguous, and effective.

Additional Reads

Explore the different facets of billing proration through a perspective-widening selection of intriguing Q&As and articles:

• Read about our new design overhaul to make this essential featureless fuzzy and more customer-friendly. Proration – A dose of intelligence

• Learn more about Proration and how you can handle it for your SaaS with the help of our blog. How does Proration work & why is it important in SaaS?

• Wish your prorated subscriptions were simpler to manage? Chargebee's got it covered. Handle prorated subscriptions with ease