What is Prorated Credit?

What is prorated credit?

Prorated credit is the partial refund amount or credit that is calculated proportionally based on the underutilized portion of a service/product customers already paid for. It is an amount of adjustment refunded based on the actual time or usage of a service within a billing cycle. If a customer cancels their subscription halfway through the month, they are liable to receive payment back for the unused portion.

In the same way, if a customer begins a service mid-cycle, they may only be charged for the few days they used the service. Prorated credit ascertains that customers are charged or refunded fairly, depending on usage of the service they signed up for.

What are some industry applications of prorated credit?

Prorated credit can be implemented in a variety of business contexts where service usage does not align with complete billing cycles or customers do not complete the billing cycle due to some reason. Here are details of some use cases of prorated credit:

Subscription-based services

Businesses using software as a service can use proration credit when agreements begin or end mid-month. When customers choose to cancel subscriptions before the billing period ends, companies can calculate prorated refunds based on the unused portion of the service. This in turn allows business-customer relationship maintenance and clarity.

If a customer pays $500 for an annual project management software subscription but cancels after 9 months, they would receive a prorated credit of $125 for the remaining 3 months. This practice ensures customer trust in your brand and instigates a sense of clarity.

Utility services and final billing

Utility companies use prorated billing as a standard practice for calculating final bills when customers move or discontinue services mid-cycle. Gas, electricity, water, and waste management companies monitor meters on certain dates and calculate charges based on actual usage during the prorated period.

For instance, if a household’s monthly billing cycle runs from the 1st to the 30th of each month, but they move out on the 20th, the utility company would prorate the final bill to cover 20 days of service.

Membership and fitness services

Gyms, membership clubs, and other membership-based organizations often deal with prorated credit cases where members relocate, experience financial strain, or choose to cancel memberships for any reason. For instance, a member who pays $480 for an annual gym membership but moves to another city after 9 months might receive a prorated refund of $120 for the unused 3 months.

Enterprise software and licensing services

Large-scale organizations that purchase enterprise software licenses often encounter prorated credit situations when they need to reduce user accounts, change license types, or cancel services before contract expiration. Software vendors typically calculate prorated credits based on the remaining contract term and the reduced service consumption.

For instance, if a company ABC has a $200,000 annual enterprise software contract but reduces user licenses by 50% halfway through the year, they might receive a prorated credit of $50,000 for the reduced service level over the remaining 6 months.

How is prorated credit calculated?

The prorated credit calculation is based on the remaining term of the contract or subscription. The formula is:

Determine the total contract value. It is the original contract or subscription amount.

Determine the remaining term: Calculate the number of remaining months or days in the contract term.

Determine the total contract term. Calculate the total number of months or days in the original contract term.

Calculate the prorated credit:

Prorated Credit = (Total Contract Value x Remaining Term) / Total Contract Term

Example:

• Total Contract Value: $120,000 per year
• Remaining Term: 6 months
• Total Contract Term: 12 months

Prorated Credit = ($120,000 x 6) / 12 = $60,000

This means the customer would receive a prorated credit of $60,000 for the remaining 6 months of the contract.

What are the advantages of prorated credit for customers and businesses?

Prorated credit has a variety of benefits for businesses and customers, such as

Advantages for Customers

Fairness: Prorated credit allows customers to pay only for the exact time span they have used a service. In case a customer decides to cancel a service in the middle of a billing cycle or begins a service halfway through a period, they are charged for only that period, and the remaining credit is refunded or adjusted in the next billing cycle.

Cost savings: Customers experience satisfaction if their expenses are reduced by avoiding overpayment for any unused services. For instance, if anyone cancels a monthly subscription on day 18, they receive a credit for the remaining 12 days. This cost-saving impact of prorated charges keeps the customers satisfied over financial matters.

Increased satisfaction: Fair billing through prorated credits enables higher customer satisfaction and loyalty. When customers feel they are treated fairly, they are likely to give positive feedback to the business. This can be fruitful for marketing efforts, offering real-time reviews and satisfaction rates.

Flexibility: Prorated credit allows customers the freedom to change their services without any penalties. They can upgrade/downgrade/cancel services at any time as per need, knowing that they won’t be charged extra for unused services.

Advantages for Businesses

Improved customer retention: Fair billing practices allow businesses to retain customers who might otherwise leave due to frustration with fixed billing practices. When customers are not worried about being penalized, they are likely to stick around your services for a longer period.

Improved reputation: Businesses that implement fair billing practices tend to have a better reputation among other competitors. Organic customer acquisition becomes easier in such cases.

Greater transparency: When businesses charge customers based on actual usage rather than overbilling or underbilling them for any unused services, it creates a sense of transparency. Businesses can manage their fiscal business aspects with ease when there is clarity on how much each customer is charged or credited back on unused services.

Compliance: In some industries, prorated billing helps businesses to comply with customer protection regulations that demand fair billing mechanisms.

What are the challenges of prorated credit?

The management of prorated credit can be challenging, especially if your business plan accommodates complex plans. Some common challenges of prorated credit include risk of miscalculations, complex billing system requirements, customer disputes, cash flow management issues, and integration difficulties with existing accounting systems.

Here are details of each of the mentioned challenges:

Risk of miscalculations

In some cases, prorated credit calculations can become prone to human error, especially when irregular billing cycles are involved. Manual calculations are often susceptible to mistakes, mainly when a business is offering tiered pricing plans, promotional discounts, etc.

As an example, calculating prorated credits for a customer who upgraded mid-cycle from a discounted annual plan to a premium monthly plan requires careful consideration of the original discount percentage, remaining time on the annual commitment, and the new monthly rate structure.

Complex billing system requirements

Implementing prorated credit functionality requires an intricate billing ecosystem capable of managing a variety of variables. Modern businesses often operate within tiered pricing structures, add-on services, volume discounts, and any promotional offers that must be factored into prorated calculations. The billing system must be capable of tracking service start and end dates, usage patterns, and plan changes while also keeping a check on payment histories.

Customer disputes

Prorated credit calculations often lead to customer frustration and disputes as they may fail to understand the proration formula. This is majorly true for annual subscriptions paid monthly or when multi-plan changes occur within a single billing period. Some common questions that instigate dispute include whether proration credit should be calculated based on calendar days or business days, how partial months must be handled, and whether certain fees are eligible for proration. These disagreements between customers and businesses can affect a business’ reputation and customer base.

Cash flow management

When customers cancel their subscribed services or downgrade their plans mid-cycle, businesses must issue immediate refunds while having already allocated that revenue for operational expenses. This situation becomes problematic for companies that offer annual subscriptions at discounted rates, as they might have to refund large amounts while having spent the money on customer acquisition, infrastructure, or other business operations.

The unpredictability of prorated credit requests makes it difficult to forecast cash flow accurately, thus requiring businesses to maintain larger cash reserves or credit facilities to handle refund obligations.

Integration challenges

Integrating prorated credit functionality with established accounting systems can pose technical difficulties. This is mainly true for businesses using legacy software systems. Prorated credits must be properly recorded across billing systems, customer relationship management platforms, and revenue recognition software, thereby maintaining audit trails and data integrity.

How does SubscriptionFlow handle prorated credit?

SubscriptionFlow manages complex prorated credit by automated proration systems, flexible proration configuration, real-time processing, multi-pricing model support, and integration with subscription management.

Automated proration system

SubscriptionFlow renders automated proration that reduces any need for manual invoice editing, strengthening the process of generating prorated invoices. The software automatically manages and applies prorated credits when customers make subscription changes, improving accuracy and efficiency.

Flexible proration configuration

The platform enables businesses to specify which clients get prorated invoices and which receive estimated and approximated ones at the time of creating invoices for customers. This flexibility allows businesses to customize their proration policies based on customer types, subscription plans, and business needs.

Real-time processing

Our subscription management platform enables real-time invoice generation, allowing customers to receive invoices instantly when they change plans, upgrade/downgrade or cancel, or even resubscribe. This real-time processing helps customers to receive prorated credits without any delays.

Multiple pricing model support

The platform facilitates proration for various custom pricing strategies such as usage-based billing, volume-based billing, tiered billing, and flat fee billing. It allows businesses with complex billing structures to implement appropriate prorated credit calculations.

Integration with subscription management

SubscriptionFlow enables proration and updates subscription data to reflect any changes made, while providing customers access to modify their subscription plans through a self-service portal. This in turn allows credit prorations to automatically apply when a customer modifies their plan.