Prorated charges: How they work in usage-based billing

Did you know that nearly 61% of SaaS companies use some form of usage-based billing? As this model grows in popularity, it's vital to understand how to charge customers fairly. It's especially important when they change their subscriptions mid-cycle. 

This article dives deep into the world of prorated charges. We’ll explain how they work and why they're crucial for accurate and transparent billing in usage-based models.

You'll also learn:

• The benefits of prorated charges for both businesses and customers
• How to calculate prorated charges effectively
• Best practices for implementing prorated billing
• How to improve customer experience with prorated charges

Let’s kick things off by explaining what a prorated charge is. 

What is a prorated charge?

‍A prorated charge is a partial payment calculated based on the proportion of a billing cycle that a customer has used a service. 

You only pay for what you use. This approach ensures fairness and accuracy in billing. It's even more important when customers start or end their service in the middle of a billing cycle.  

Industries that commonly use prorated charges

The meaning of prorated charges is consistent across sectors. It always refers to this proportional payment method. Similarly, the meaning of a prorated fee is any fee that’s adjusted proportionally to the usage period. Here are two particular examples:

• Utility companies rely on prorated billing. Imagine moving into a new apartment on the 15th of the month. Your electricity bill would be prorated to reflect only the 15 days you actually used the service.  
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• Telecommunications companies are another prime example. Let's say you add an international calling plan to your phone service mid-month. You'll likely be charged a prorated fee for that add-on, covering only the remaining days of the billing cycle.

Benefits of prorated charges in usage-based billing

Prorated charges offer several advantages in usage-based billing models. Here's how they can benefit your business:

• Fairness first: Prorated charges prevent overcharging or undercharging customers. They do so by aligning costs with actual usage. Customers only pay for the services they receive, leading to greater billing accuracy.
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• Trust builder: Implementing prorated billing demonstrates transparency and fairness in your billing practices. When customers see they are charged fairly, it strengthens their relationship with your business.
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• Flexibility for all: Prorated charges allow for mid-cycle changes without penalizing customers. Think upgrades or downgrades. This approach empowers customers to adjust their service levels as needed, knowing they won't face unfair charges.
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• Happier customers: By guaranteeing fair and accurate billing, prorated charges lead to happier customers. Happy customers are more likely to remain loyal to your business.
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• Reputation booster: Prorated billing showcases your commitment to ethical and customer-centric practices. It can greatly boost your business reputation too.

How prorated charges work

Prorated charges confirm that customers pay only for the services they use, even when changes occur mid-cycle. Let's break down how these charges work in usage-based billing.

‍When are prorated charges applied?

‍Prorated charges typically come into play in a few common scenarios:

• Starting a subscription mid-cycle: When a customer signs up for a service partway through a billing cycle, a prorated charge ensures they only pay for the remaining portion of that cycle.
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• Upgrading or downgrading a plan: If a customer changes their subscription level mid-cycle, prorated charges accurately reflect the cost of each plan for the time it was used.
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• Adding or removing features or users: Similarly, when customers add or remove features within their subscription, proration ensures they're charged proportionally for the time they used those features.
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• Canceling a subscription before the end of the billing period: If a customer cancels their subscription early, a prorated refund or credit is calculated for the unused portion of the service.

The formula for prorated charges

‍The basic calculation for prorated charges is straightforward:

‍(Total Subscription Cost / Total Days in Billing Cycle) x Number of Days Used = Prorated Charge

‍This formula allows you to determine the exact amount owed based on the daily rate and the number of days the service was used.

‍Example scenario: Upgrading a SaaS plan

Let's say a customer subscribes to a SaaS plan that costs $100 per month. On day 10 of a 30-day billing cycle, they decide to upgrade to a premium plan that costs $150 per month. Here's how the prorated charge would be calculated:

1. Calculate the daily rate for each plan:
   
   • Basic plan: $100 / 30 days = $3.33 per day
   • Premium plan: $150 / 30 days = $5.00 per day
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2. Calculate the cost for the time each plan was used:
   
   • Basic plan (10 days): $3.33/day x 10 days = $33.30
   • Premium plan (20 days): $5.00/day x 20 days = $100.00
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3. Add the costs together to get the total prorated charge: $33.30 + $100.00 = $133.30

In this scenario, the customer would be charged $133.30 for the month, reflecting the prorated costs of both plans.

Best practices for handling prorated charges in usage-based billing

Effectively managing prorated charges is essential for maintaining accurate billing and keeping your customers happy. Here are four best practices to consider:

‍1. Automate, automate, automate

‍Modern billing platforms can be your best friend when it comes to prorated charges. These platforms can automatically calculate prorated charges in real time, eliminating manual calculations and reducing the risk of errors.

‍Remember: Investing in a robust billing system can save you time and guarantee accuracy in your billing processes.

2. Communication is key

‍Clear communication is crucial for any billing practice, but especially when prorated charges are involved. 

Always provide detailed invoices that clearly show the calculations behind any prorated amounts. This transparency helps customers understand their bills and builds trust in your billing practices.

3. Integrate with usage tracking‍

To secure the accuracy of your prorated charges, it's key to link your billing system with your usage tracking data. 

By integrating these systems, you can automatically capture accurate usage information and ensure that your prorated charges reflect actual consumption. This approach eliminates discrepancies and promotes fairness in your billing.

4. Test, test, and test some more

‍It's crucial to thoroughly test different scenarios. Simulate various customer actions, such as upgrades, downgrades, and cancellations, to validate that your prorating logic works correctly.

Testing helps prevent unexpected billing errors and ensures a smooth experience for your customers.

Prorated charges vs. flat-rate billing

When setting up your billing structure, you have two primary options: flat-rate billing or prorated charges. Each has its own set of pros and cons, so it's vital to understand the differences to choose the best fit for your business and your users. Let’s take a closer look.

Flat-rate billing: Simplicity first

Flat-rate billing is straightforward. Customers pay a fixed amount regardless of when their service starts or ends within the billing cycle. Here are the pros and cons:

• Pros: The main advantage is its simplicity. It's easy to understand and explain to customers, and it requires minimal calculations. This can be especially appealing for businesses with simple pricing models or limited resources.
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• Cons: However, flat-rate billing can feel unfair to customers who start or end their service mid-cycle. This lack of flexibility can lead to customer dissatisfaction and potentially impact acquisition and retention.

Prorated charges: Fairness and flexibility

Prorated charges, on the other hand, adjust the charges based on the actual usage time within the billing cycle. Here are the pros and cons of prorated charges:

• Pros: Prorated charges are inherently fair and transparent. Customers pay only for what they use, which fosters trust and enhances satisfaction. It also encourages flexibility, allowing customers to make changes to their service without feeling penalized.
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• Cons: Implementing prorated charges requires more advanced billing systems and clear communication to avoid customer confusion. You'll need to confirm your systems can calculate and apply prorated amounts, and your invoices should clearly explain the breakdown of these charges.

How to improve your customer's experience with prorated charges 

Prorated charges can be a fantastic tool for building customer trust and providing a fair billing experience. However, they can also cause confusion if not handled properly. Here's how to confirm your customers have a positive experience with prorated charges.

‍Tip 1: Communicate diligently

‍Keep your customers informed every step of the way. Notify them immediately about any billing adjustments due to prorated charges. 

For instance, when they upgrade or downgrade their service, send a confirmation email outlining the prorated amount and the new recurring charge. Proactive communication prevents surprises and demonstrates transparency.

‍Tip 2: Simplify invoice design

‍Use clear language and avoid jargon when presenting prorated charges. Provide a detailed breakdown of the calculations, showing the daily rate, the number of days used for each service level, and the total prorated amount. 

‍Remember: A well-designed invoice makes it easy for customers to understand their charges.

‍Tip 3: Use predictive analytics (when possible)

‍Consider leveraging predictive analytics. By anticipating their needs for upgrades or downgrades, you can prepare prorated calculations ahead of time and proactively communicate potential billing adjustments. 

‍Tip 4: Leverage customer education

‍Empower your customers with the knowledge they need to understand prorated charges. Provide resources like FAQs or help articles on your website that clearly explain how prorated charges work. Consider including a brief explanation on your invoices as well. 

Educating your customers promotes transparency and minimizes billing inquiries.

Orb’s platform simplifies calculating prorated charges for you

We've explained what prorated charges are and how they contribute to a fair and transparent billing experience. Now, let's talk about the importance of having a billing platform that can help you bill users accurately and implement any pricing model you want.

‍Orb is a done-for-you billing platform. It empowers businesses to take control of their recurring revenue strategies. With Orb’s extensibility, you gain the flexibility to manage complex usage-based billing scenarios, including prorated charges, with ease and accuracy.

‍Here's how Orb can simplify calculating prorated charges and elevate your billing process:

• Accurate proration, every time: Orb's metering infrastructure accurately tracks usage by capturing every billable event. This allows for precise calculation of prorated charges, eliminating manual errors and ensuring your customers are billed fairly.
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• Easy plan switching for pricing agility: Orb's plan versioning features make it simple to manage new, current, and legacy pricing plans. The platform automatically calculates prorated charges when customers switch plans mid-cycle.
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• Real-time insights into usage: Orb provides detailed financial reports and real-time usage data. Orb allows you to monitor customer behavior, anticipate potential upgrades or downgrades, and proactively manage prorated charges.
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• Integration with your tech stack: Orb integrates with popular data warehouses and accounting software, providing a simplified billing operation. This integration helps maintain data consistency and reduces the risk of errors in prorated charge calculations.
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• Customizable billing logic: Orb's intuitive interface and custom SQL editor allow you to define your own usage metrics and tailor your pricing models to your specific needs.

Ready to simplify prorated charge calculations? Check our flexible pricing options to find a plan that aligns with your business needs and budget.