What Is Pro Rata?
Pro rata is a Latin term meaning “in proportion,” which pertains to the distribution of an item proportionate to its share of the whole. If something is allocated on a pro rata basis, each recipient gets an amount relative to their share—a principle often applied in business finance.
Key Takeaways
- Pro rata ensures everyone gets their fair share.
- Commonly, it refers to dividends paid to investors proportional to their investment.
- Rooted in fractions, pro rata makes two fractions equal but with different denominators.
- It applies in areas like billing, dividend payout, and allocating business income.
- The ratio is determined by dividing the given instance quantity by the maximum possible quantity, which can then be applied to related items to find proportional amounts.
Understanding Pro Rata
Pro rata ensures fair share distribution in various domains like dividend payments which corporations pay to shareholders.
In insurance, pro rata calculates the premium for policies covering partial terms. It’s also used to allocate annual interest rates over shorter periods.
For instance, in retirement accounts containing both pre and post-tax dollars, pro rata determines proportionate taxable amounts for distributions. If a 401(k) account has 20% pre-tax dollars and 80% post-tax, any withdrawal comprises 20% taxable and 80% non-taxable funds.
How To Calculate Pro Rata
Pro rata is calculated using:
- The number of items true or owned.
- The total possible quantity of that item.
- The related item’s quantity being assigned as per the above information.
Formula:
1Pro Rata Share = (Number of True Items / Maximum Quantity Possible)
2Pro Rata Distribution = Pro Rata Share * Quantity of Related Item
Example:
Imagine an employee eligible for a $10,000 bonus this year. If they leave on March 20th, their prorated bonus is as follows:
- Days worked until March 20 (non-leap year): 79 days
- Maximum days per year: 365 days
- Pro Rata Share: 79 / 365 = 21.64%
- Pro Rata Distribution: 21.64% * $10,000 = $2,164
So, the employee receives $2,164 for 79 days worked.
Why Pro Rata Works
Pro rata is effective as it ensures that proportional equivalence is maintained by applying a fraction of one item’s quantity to another. This is fundamentally grounded in maintaining equal fractions with different denominators.
Examples of Pro Rata
Pro Rata and Dividends per Shareholder
Dividends are distributed based on shareholders’ holdings. If a company issues $2 per share as dividends, with 100 shares outstanding, the total payout is $200. For shareholders holding 50, 25, 15, and 10 shares:
- Major shareholder’s share: (50 / 100) * $200 = $100
- Others receive $50, $30, and $20 respectively.
Pro Rata for Insurance Premiums
Consider a 12-month auto policy with a $1,000 premium but needed only for 270 days:
Pro Rata Premium = ($1,000 / 365) * 270 = $739.73
Pro Rata for Interest Rates
If an investment yields 10% per annum, earned interest for 2 months is:
Pro Rata Interest = (10% / 12) * 2 = 1.67%
In bonds, payment on accrued interest before the next coupon date is calculated for time held since the last coupon and proportional to the coupon rate.
What Does Pro Rata Mean?
Pro rata signifies a designated portion based on one’s fraction of the whole. E.g., 10% building ownership expects 10% rental income.
What Is the Difference Between Prorated and Pro Rata?
“Prorated” and “pro rata” are terms used interchangeably representing the same proportional allocation concept.
How Do I Calculate Pro Rata?
Calculating pro rata varies; divide an annual rate/evaluation by total units (e.g., months) and multiply by the units applicable.
Pro Rata Application to Dividends
For instance, a major shareholder with 50% holdings in a 1,000-share company receiving $1 dividends per share gets:
($500 / 100%) x $1,000 = $500
What Is a Pro Rata Discount?
Merchants offer pro rata discounts, reducing prices proportionally. E.g., $20 off on a $100 purchase, each of four products gets $5 off, or on a mid-month subscription enrollment, customers pay for service days used, reflecting pro rata discount.
Now, you’re equipped with comprehensive knowledge about pro rata and its significance in fair distribution across business and financial scenarios.
Related Terms: Prorated, Fractional Shares, Proportional Allocation.
References
- Internal Revenue Service. “Rollovers of After-Tax Contributions in Retirement Plans”.
- Compass Insurance Agency. “Prorated Insurance Rates Explained”.
- FasterCapital. “How Accrued Interest Is Calculated in the Bond Market”.
