What is Pro Rata?
Pro rata is a Latin term that means “in proportion,” referring to the proportional allocation or distribution of something.
Pro rata refers to the equal division of something — It could be an interest rate, expenses, dividends, or another sum that is divided among a certain number of people or across a certain amount of time. The term can be used in any field, but it often appears in finance. To calculate a pro rata share, divide the total by the specified number of units. Pro rata is often used interchangeably with “prorated.”
Let’s say fictional Retail Company A announces that, in the fourth quarter of the year, it will pay out $1M in dividends to shareholders. Each share will be worth a pro rata amount, meaning a proportionate amount of the dividends being paid out. If there are 500 shares in circulation, the pro rata amount that each share is worth is $2,000 ($1M divided by 500 shares).
Pro rata is kind of like dividing up a pie…
If you’ve got one pie and plan to share it with five of your friends, you have to divide the pie up six ways. Each person’s pro rata share of the dessert is equal to one-sixth of the pie.
Pro rata comes up in many situations, both in finance and everyday life. The term is often used interchangeably with “prorated,” which also refers to the proportionate distribution of something, whether it be dividends, wages, or interest rates.
Determining pro rata is simply a matter of dividing the total number of something by the number of parts. As a simple example, if you have a total of 100 units of something to be divided into 5 equal parts, each pro rata share is 20 units (100 units ÷ 5 parts = 20 units per part).
Here are some examples of situations in which pro rata often comes up:
In the finance world, pro rata is often used to determine the amount a shareholder will receive in dividends. When a company pays dividends, each shareholder receives an amount that is proportional to the percentage of shares they own.
Let’s say there are a total of 500 shares in a company, and the company is paying out $500,000 in dividends. By dividing the total amount of money by the number of shares, you can determine that each share entitles you to $1,000 of the dividends. If a shareholder owns 15 shares (or 3% of total shares), he will receive $15,000 in dividends (or 3% of the total dividend amount).
Pro rata plays an essential role in joint ventures (when two or more people start a business together). Joint ventures can include limited liability companies, corporations, and partnerships. Someone’s ownership stake in a company determines his or her share of the costs and profits. Here’s an example of how pro rata would come into play in the case of a partnership:
Liability: A partner’s level of liability (the costs he or she is responsible for) in a business is determined on a pro rata basis that corresponds to his or her stake in the company. Let’s say a partnership is sued for $100,000 and loses. Partner A has a 60% interest in the company, while Partner B owns 40%. Each partner’s pro rata share of the liability would equal his or her stake in the company. Partner A is liable for 60% of the debt (in this case, $60,000), and Partner B is responsible for 40% ( or $40,000).
Profit: Just as with liability, a partner’s pro rata share of profit in a partnership is based on his or her interest in the company. If the same company’s profit comes to $750,000, Partner A gets $450,000 (60% of $750,000) and Partner B gets $300,000 (40% of $750,000).
Pro rata can be used to divide interest rates into smaller units — often an annual rate into a monthly one. For example, if the yearly interest rate for a loan is 12%, the monthly rate is 1% (12% ÷ 12 months).
Pro rata can come into play if you cancel an insurance policy early. If you paid $600 for six months of insurance and canceled after three months, the insurance company would return a pro rata amount. In this case, since you canceled halfway through the policy, you would be eligible for a 50% refund.
Pro rata also comes up when determining your monthly payment. Often insurance companies price a policy over a six or 12 month period, but many customers don’t want to pay their premium in one lump sum. Instead, insurance companies divide the premiums so that customers pay a prorated amount each month. If your car insurance premium for a six-month period was $510 but the provider agreed to prorate it, you would owe $85 a month.
Another example of pro rata is the division of a loan into monthly payments. When you take out a loan — whether it’s a personal loan, car loan, or mortgage — the balance is divided out across the entire life of the loan. This, in combination with interest, is how the lender determines what the monthly payment will be.
Pro rata often comes up with apartment rentals. In most cases, rent is charged monthly, but what if you aren’t living in the unit for an entire month? Perhaps your lease starts a few days into the month or ends in the middle of the month.
In this situation, the landlord is likely to prorate your rent, or only charge you based on the number of days you spend in the apartment.
For example, let’s say your monthly rent is $1,200, and your lease starts on Sept. 3. Your landlord would calculate the pro rata amount you owe by determining the daily cost of your rent and multiplying that by the number of days you were in the apartment.
Since September has 30 days, the landlord would divide 1,200 by 30 to determine the daily rate, which comes out to $40. Then, he or she would multiply the daily rate by the number of days spent in the apartment, or $40 x 28 days. You end up with a total of $1,120.
One of the more common uses of pro rata applies to salaried employees. Generally, a salary is compensation that is expressed as an annual sum, rather than an hourly one. Salaries usually assume the employee is working for the entire year for a minimum number of hours per week (usually 40).
If you’re an employee who earns an annual salary, pro rata is used to determine how much you get in each paycheck. For example, let’s say you earn a yearly salary of $75,000 and get paid every two weeks. You’ll receive 26 paychecks per year, so your employer would take your total salary and divide it by 26 to determine how much you should be paid every two weeks. The result would be a biweekly paycheck of $2,884.62.
If you got paid twice a month, rather than every two weeks, you’d receive 24 paychecks a year. Dividing $75,000 by 24 leaves you with a paycheck of $3,125. If you got paid monthly instead, each paycheck would amount to $6,252. Each of these models results in the employee getting the same amount of money over the course of the year — It’s simply a matter of how many paychecks the amount is spread out over.
Pro rata can also be used to figure out how much a part-time worker gets paid. For example, imagine an employee is salaried but only works 20 hours per week. Suppose the annual full-time salary for the position is $50,000. Simply divide the number of hours the employee works (20) by the number of hours the full-time salary is based on (40) to come up with the percentage of the full-time salary the worker should be paid — in this case, 50%. Next, multiply that percentage (50%) by the annual full-time salary of $50,000. So the employee in this situation will be paid an annual part-time salary of $25,000 per year.
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