What does prorate mean?

Prorate means to evaluate or divide something proportionately. Many people in business define ""prorated"" as adjusting the cost of a service or product based on the portion actually used.

For example, let's say your company offers a service that costs $15 per month and a customer signs up on the 21st of the month. You could prorate that customer $5 for the month since they will only be using the service for one-third of the month.

How does proration work?

Since the concept of proration is derived from the term ""pro rata,"" it means that an asset will be divided and distributed into equal parts. Generally, proration works by determining how much each equal portion of time ""costs"" and multiplying that cost by the amount of time someone is using the asset.

Suppose a car insurance company charges a driver an insurance premium of $492.90 per month for a six-month policy on a truck. If the insured cancels his policy after four and a half months of the six-month policy, the insurance company must refund the customer for the time the policy has not been used.

The insurance company may use the following steps to determine proportionate reimbursement:

1. Monthly cost x policy term = total premiums: $492.90 x 6 = $2,957.40
2. Total premiums / number of days in the term = daily insurance premium (January 1 to June 30 is usually 180 days): $2,957.40 / 180 = $16.43
3. Daily premium x unused days = refund amount: $16.43 x 46 = $755.78

You can also calculate proration by determining that the customer used the policy for 134 days between January 1 and May 15 and multiply that by the daily rate of $16.43. Then, you would subtract that total amount from $2,957.40 to get the same prorated value.

What is proration used for in business?

Proration has many uses in the business world, from payments for stock ownership to calculating employee pay. Here are four ways proration is useful as a tool for determining pay and the allocation of other resources.

dividends

If a company has 100 shares for which it pays $30 per share, it must pay shareholders $3,000 for those shares. However, when it comes to dividends, shareholders do not receive equal payments. Instead, companies pay each shareholder according to the number of shares he or she currently owns.

For example, one shareholder may have 50 shares, another 30 shares, and a third 20 shares. In this case, those shareholders would be paid $1,500, $900, and $600, respectively. A total payment of $3,000 is determined for all shares, and then the individual payments are divided proportionately among the shareholders.

Monthly Payment

Businesses of all types use proration to adjust monthly payments for customers who do not use the service for the entire month. This often happens when someone rents an apartment in the middle of the month or terminates their lease before the term ends. It is also often used for utility and insurance premium payments when a customer signs up before the new month begins.

To calculate the prorated payment, the real estate, utility or insurance company typically divides the monthly total amount by the number of days in the month, yielding a daily rate. The company will then multiply the daily rate by the number of days the customer actually uses the asset.

staff salary

HR professionals use prorationality to determine the amount of pay an employee should receive based on the actual time worked. For example, an employee may earn an annual salary of $150,000. However, if that employee begins working on May 1 instead of January 1, he or she will only receive two-thirds of his or her salary for the year.

This means that, for the first year, the employee will receive $100,000. Once the new year arrives, the employee will be paid their normal annual salary of $150,000, provided they work a full 12 months. Proration can also be applied to annual bonuses.

It’s important to prepare new employees for this reality, especially because their payroll and W-2 will reflect this lower, prorated pay.

Paid Leave (PTO)

PTO is another area in which HR professionals need to use the concept of proportionality. For example, a company that provides 21  sick leave  , vacation or personal days (168 hours) per year may only provide 10.5 days (84 hours) to employees who start a job mid-year.

In some cases, you may choose to prorate PTO based on the hours the employee works. This is called the ""accrual"" method. For example, an employee may receive two hours of sick leave for every 30 hours worked. If the employee only works 15 hours, you may only give him or her one hour of sick leave.

It is important to pay attention to your state's labor laws when deciding how to proportion vacation and sick leave time. Some states have laws that specifically explain  how to calculate paid leave  and enforce minimums and maximums for certain occupations in the private sector.

Benefits of Proration

If you are wondering, ""What is the biggest benefit of proration?"" the answer is that there are several major benefits. How much a person benefits from this practice depends on which side of the business equation he or she is on.

customer benefits

Customers benefit from proportionate profits, as they are able to pay a fair (and often lower) price for the services they receive from a business.

Proration also offers customers the gift of flexibility. They can use the service whenever they need it instead of waiting until the beginning of the month. This is important when it comes to moving into a new home or signing up for car insurance or utilities.

Benefits for Businesses

Because prorating is a fair practice, it helps businesses build an excellent brand reputation. This, in turn, allows customer service representatives to build positive relationships with customers and earn their trust and loyalty more easily.

Proportionality can help businesses stand out as the preferred choice in the market if competitors are not doing the same.

Finally, understanding the concept of proportionality helps businesses comply with wage and paid leave laws. Not only does this reduce the risk of audits and lawsuits, but it can also increase employee morale, engagement, and trust.

Best Practices When Prorating

What does it mean to prorate effectively? Organizations and HR professionals must have clear policies, consistent methods, and excellent record-keeping skills to do so. Otherwise, it can be difficult for both clients and employees. Here are some best practices that can help you avoid common challenges associated with this practice.

Honesty

It is important to inform customers and employees of all policies relating to proportionality.

If an employee's pay or benefits will be prorated, let them know verbally and in writing in their employee contract and employee handbook.

The proportionate information should appear in any communications you have with customers regarding payments, including the terms and conditions of their service agreement and any bills or invoices you send.

Stability

Your prorated policy should be applied equally to all parties without exception. This is why it is best to follow the written policy and formula you use for all prorated calculations.

If you're not consistent, you could leave yourself or your company open to charges of discrimination, lawsuits, and compliance issues. It   could also impact your employer brand or your reputation with customers.

Tracking

It's important that your business has a way to track which customers or employees are receiving proportionate rates, wages or benefits. Otherwise, incorrect calculations can be costly, especially when it  comes to issuing refunds, paying employees correctly or estimating payroll taxes owed to the IRS  .

Having a digital platform to help track these things automatically can help avoid problems in this area.