Proration, in the SaaS sector, refers to the action of adjusting the amount of a customer’s invoice on a pro-rata basis* to reflect changes made to a subscription during a period.
*Prorata temporis is a Latin expression meaning in proportion to the time elapsed.
Proration allows for optimized billing
Proration can be summarized in a simple use case
If a group of customers has a subscription to monthly Plan A for 20 days and then switches to monthly Plan B for the remaining 10 days, they should be billed at the price of Plan A for two-thirds of the month and at the price of Plan B for the remaining third.
As you can see, this ensures that they are accurately billed for the portion of the services they have used, taking into account their actions on their subscriptions (plan change, quantity modification, add/remove options, etc.) before the end of the current period.
Let’s now consider 3 simple cases
Proration with an upgrade to a higher plan
Let’s consider two cases of simple underutilization:
When a subscription switches to a higher plan (upgrade), calculate the amount for the remaining period on the new plan and add it as a line item to the next generated invoice.
Current plan: $100/month
New plan: $150/month
Proration logic:
- $100 was paid at the beginning of the period.
- Assuming the plan change happens exactly halfway through the period.
- So, the customer has consumed half of the subscription on the current plan, which is $50 (100 * 1/2 period).
- They have a remaining prorated credit of $50 (100 * 1/2 period).
- The customer will use the new plan for the remaining period: $75 (150 * 1/2 period).
- Net result of this plan change after adjustment: $25 ($75 – $50).
Proration with a downgrade to a lower plan
When a subscription switches to a lower plan (downgrade), the customer is more likely to have paid more than the intended usage halfway through the period. There will be a net credit to the customer. This should be reflected unambiguously in the billing lines.
Current plan: $150/month
New plan: $100/month
Proration logic:
- $150 was paid at the beginning of the period.
- Assuming the plan change happens exactly halfway through the period.
- So, the customer has consumed half of the subscription on the current plan, which is $75 (150 * 1/2 period).
- They have a remaining prorated credit of $75 (150 * 1/2 period).
- The customer will use the new plan for the remaining period: $50 (100 * 1/2 period).
- Net result of this plan change after adjustment: -$25 ($50 – $75).
You owe the customer $25. This amount will be automatically deducted from the upcoming invoices.
Proration for modifications within a subscription during a period
Let’s imagine the subscription includes users billed at $100 each.
The customer wants to add a user in the middle of the period and then remove a user three-quarters into the period.
Let’s do the calculation with the addition of a user:
- The customer will benefit from an additional user for the remaining period: $50 (100 * 1/2 period) will be added to the next invoice.
- The customer removes a user for the remaining period: -$25 (-100 * 3/4 period) will be added to the next invoice.
- In the next invoice, the customer will owe $25.
Is proration necessary?
If you’re just starting out, implementing a proration system may seem like too much effort. Why not simply remove the possibility of changing plans mid-cycle and implement non-prorated billing? Several companies do choose this solution. However, while it may seem deceptively simple and hassle-free at first, you’ll quickly realize its drawbacks.
Without proration, you would have to charge more than what a customer consumes if they want to downgrade or leave them stuck on a lower plan if they want to upgrade until the end of the current period. In the first case, the customer will feel unfairly overcharged with no possibility of a refund, and in the second case, you lose out on revenue. Neither is good for you or your customers.
To summarize, proration is the smartest way to balance clean and transparent accounting on your end and offer convenient billing options to customers. And while you can leave it out if you want, you’ll surely miss it as your customer base grows.
Teasing question: How can you refund customers who downgrade mid-period?
Without a subscription management and billing solution like ProAbono, you would have to:
- manually credit the customer’s account with the remaining amount to be included in the next invoice,
- or issue a refund. And what if the invoice generated for the current period hasn’t been paid yet? You can’t refund money you never received.
With ProAbono, it’s clear, unambiguous, and efficient.