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Prorated billing refers to the technique of charging your customer only for the period they have used your service or product. This form of billing is very relevant for SaaS or subscription model businesses. But, what makes it stand apart from the other traditional styles of billing? In a subscription business model, the revenue stream, and orders are recurring in nature. When a customer signs up for a subscription, they agree to pay a particular amount at a regular interval in return for using a product or service.
The billing amount depends on the plan the customer has subscribed to and the length of time they are subscribed to it. In the usual scenario, the customer remains subscribed to the same plan and makes the recurring payments accordingly. But the billing becomes a little challenging when the customer decides to switch plans or make other tweaks before the next billing date. In such cases, the billing amount has to be calculated based on the number of days under a particular plan - in other words, on a proportional basis. This is what is known as prorated billing.
Why do you need prorated billing for your subscription business?
It is a fair practice. Customers pay only for the days they have used a product or service. This will keep your customer complaints low and help build trust.
You are always prepared. With prorated billing, you can allow customers to make changes to their subscriptions at any time instead of waiting for the end of the billing period. Whenever they decide to make a change, you'll know how to bill them for it.
It's safer for your revenue stream. Prorated billing means there's never a time when the customer is receiving a higher level of service than they paid for, so you can introduce more plans and add-ons without incurring losses while customers are switching.
When does prorated billing help your subscription business?
If you run a subscription business or plan to start one, these are some of the scenarios where prorated billing comes into the picture.
Upgrading a planDowngrading a plan
A customer who's currently subscribed to a plan might decide to switch to a higher plan with different pricing and a different set of benefits. If your subscription business gives customers the flexibility to upgrade their plan on any given day, then you'll need prorated billing to find out the actual amount that the customer should pay for the upgrade. Here's a small illustration of how prorated billing helps when a customer decides to upgrade their plan:
If your subscription business gives customers the flexibility to upgrade their plan on any given day, then you'll need prorated billing to find out what the customer owes in addition to their current monthly payment.
What happened here?
Your customer made the decision to move to a higher-tier plan before the next billing date (May 5th), so the bill has to be adjusted on a pro-rata basis for the period they were still using the lower-tier plan. To do that, you need to calculate the per-day amount owed by the customer for the lower-tier plan. This amount is then multiplied by the number of days under that plan (10 days), and the result is deducted from the total amount to be paid for the higher tier plan. However, because the plan has been switched before the next billing date, you need to calculate the per day charge of the higher-tier plan ($500/30) and multiply by the number of days remaining in that month (20). The credits that we calculated, earlier has to be debited from this final amount.The remaining amount is the actual amount that the customer owes until the next billing date [($500/30)*20]-$200 = 133.33.
In this scenario, instead of upgrading, your customer switches to a lower plan. The calculations are similar, but this time instead of asking the customer to pay an extra amount above their previously-paid subscription amount, there will be a credit that has to be adjusted against the customer's next billing. The following illustration will give a better idea of how the calculations work:
What happened here?
The steps are similar to the previous example, but the customer has decided to downgrade the plan. So, this time we will calculate the amount owed per day and deduct it from the lower-tier plan amount. But, again you will not deduct the entire lower-tier plan amount. Calculate the per day charge of the lower tier plan ($100/30) and multiply it by the number of days remaining in that month (15). The amount that you get has to be deducted from the credits ($150). The excess of $100 will be adjusted in the next month's billing.
What's next?
Prorated billing is a great way to deal with subscription changes, but doing the math manually is time-consuming. If you have a lot of customers making changes, you can end up overwhelmed with calculations, and it's easy to start making mistakes. Switching to subscription management software that calculates your prorated billing for you can not only save you time, but also prevent costly errors.
Checkout Zoho Subscriptions
Zoho Subscriptions is cloud-based software designed to manage prorated billing and subscription plans. Take a look at our features which can help you with the day-to-day management of your subscription business.
Zoho is a software company that ships 45+ products globally. Operating on a subscription pricing model for more than 20 years has given us the opportunity to face and overcome the practical pain points of subscription businesses. Let us solve your subscription billing challenges, together.
Sridhar Vembu
CEO, Zoho Corporation
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