Pro rata is a Latin term – meaning “in proportion” – that is used to assign or allocate value in proportion to something that can accurately and definitively be measured or calculated. In North American countries, pro rata is often referred to or referenced as “prorated.”
Usefulness of Pro Rata
Pro rata literally means the division of something to make up a whole. It doesn’t mean that all parts are equal, but that each piece is given value in proportion to something else. It is particularly useful when the exact value of something can’t be easily determined by itself, but can easily be assigned a proportion value when compared to something else.
Example of Pro Rata in Action
Examples of pro rata being used include the division of a loan payment being adjusted monthly. The total amount paid by the borrower against the loan is the same each month. However, the amount of monthly payments that are allocated between the principal payment and the interest paid for the loan change each month as the loan is progressively paid off.
Dividend payments are a classic example of pro rata since dividends are paid per share. Shareholders receive dividends in direct proportion to the number of common stock they own.
For example, assume Company ABC announces they are paying a $750,000 cash dividend for its shares. If the company owns 250,000 outstanding shares in the market, each dividend share is prorated to $3. The pro-rata amount is determined using a simple formula:
Per Share Dividend = Total Dividend Amount / Total Number of Outstanding Shares
Using the information provided above, we get the per share dividend amount:
750,000 / 250,000 = $3 per share
Pro Rata in Everyday Life
Even if you’re not an investor or working in the financial world, you will probably still encounter pro rata at some point in your life. For example, if you’re moving into an apartment on any day other than the first day of the month, then your landlord is likely to pro-rate your rent for the month.
They will do so by dividing the total monthly rent due by the number of days in the month to determine the amount of the rent that is proportionate to each day. They will then multiply that amount by the number of days that you will be occupying the apartment that first month.
For example, let’s say you are moving in on 15 March and your monthly rent is $700, calculate your pro-rata rent for the month.
1. Determine your rent pro-rated per day.
$700 / 31 (No. of days in March) = $22.58
2. Calculate the pro-rata rent for the month.
$22.58 x 16 (No. of days of occupancy) = $361.28
The pro rata system or the ability to prorate is especially useful whenever it’s necessary to allocate or reallocate single units of measurement across even smaller units or pieces. The buying and selling of goods or services sensitive to time – and the companies responsible for the buying and selling – are the primary users of the pro rata system of allocating value.