Proration in finance: What it means, how to calculate it, and common examples

When you sign up for a service in the middle of the month, or move out of an apartment before the lease ends, what are you obligated to pay?

Oftentimes instead of paying the full amount, you’d only pay for the time you used the service or occupied that space.

This principle, known as proration, ensures fairness in personal and business dealings by aligning costs with actual usage, ownership, or time.

In this article we’ll define proration, learn how to calculate prorated amounts, and explore some real-world examples to demonstrate the impact of proration on your personal and business finances.

Let’s dive in.

What does prorated mean?

The phrase “pro rata” is Latin for “in proportion”.

In other words, proration involves dividing something into parts based on proportion of ownership, usage, or time. To prorate is to ensure fairness among all parties in personal and business dealings.

For the purposes of this discussion, we’ll explore proration in the context of time. To prorate based on time, you’d multiply the total amount by the ratio of time used to total time in the period.

Stated more simply:

Prorated Amount = Total Amount * # of Days Used / Total Days in Period

For example, let’s say you purchased a subscription service halfway into the current billing cycle. In this instance you’d only owe half the advertised monthly price, reflecting the time you were enrolled in the service.

Let’s explore some examples of how proration works in various financial contexts.

Proration in finance

In finance, there are several instances where proration comes into play. These instances generally involve a payor (one who pays) and a payee (one who receives payment) and include:

• Rent
• Profits
• Interest
• Insurance
• Subscriptions
• Property Taxes

If you enter into one of these obligations in the middle of a billing cycle, your first month (or year) will likely be prorated. When that’s the case, you’d only pay in proportion to the time you benefited from the service.

Let’s explore some of these examples in more detail.

Prorated rent

If you move into an apartment or office mid-month, you’d pay a prorated amount relative to the number of days you occupied that space.

For example, let’s say you moved into a new apartment on June 11 and your standard monthly rent is $1,500 / month.

Because you only lived in the apartment for 20 days, you’d only owe the landlord 20 days of rent for the month of June.

Here’s how you’d calculate exactly how much you owe for the month of June:

Prorated Amount = $1,500 * (20 days / 30 days) = $1,000

For the months of July and onward, you’d pay the full amount, assuming you lived in the apartment for the entire month.

Prorated subscriptions

When you sign up for a subscription-based service, you’ll usually pay upfront for that service. However, if you cancel your subscription before the month ends, you may be eligible for a prorated refund.

For example, let’s say you bought a website subscription on the 1^st of the month. Five days later (on the 6^th) you decide to cancel.

Assuming you’re eligible for a partial refund, the website owner will issue a credit for time you didn’t use. In this instance you’d calculate a prorated amount to determine how much you were liable for, then subtract it from the amount you paid at the beginning of the month.

Here’s how the calculation would work:

Amount You Owe: $50 * (6 days / 30 days) = $10

Prorated Refund: $50 - $10 = $40

Prorated property taxes

When you buy a home, you’re responsible for property taxes beginning the day you close on the property.

Let’s say you bought a home on March 6. Your county bills property taxes biannually (twice a year), and your first tax bill is $2,000.

Since you didn’t own the property for the first two months and five days of the year, you’d receive a credit from the seller at closing in proportion to the time they owned the property.

Here’s how you (or your title company) would calculate how much of a credit the seller would owe you at closing:

• Step 1: Determine how many days the seller owned the home for the period. In this example, the seller owned the home for 64 days this year (31 days in January, 28 in February, and 5 days in March).
• Step 2: Divide the number from Step 1 by the total number of days in the period. Remember, taxes are paid biannually, and there are 181 days between January 1 and June 30.
• Step 3: Divide Step 1 by Step 2, then multiply it by the total amount owed.

Using the formula from above, here’s how to calculate the seller credit you’d receive at closing:

Seller Credit = $2,000 * (64 days / 181 days) = $707.18

What to take away on proration

Proration is a fundamental concept that ensures you only pay for what you use or own.

To calculate the prorated amount, multiply the total amount by the ratio of time used to a larger time period, such as a month or year.

Whether you’re adjusting rent payments, calculating refunds, or apportioning property taxes, proration helps ensure equity and fairness in personal and business dealings.

Understanding how to properly apply proration can help save you money and prevent disputes, making it an essential skill in managing your finances.

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