Definition: A pro rata share is a part of the whole that is allocated on a proportionate basis. Common expenses could be allocated to different departments in a company, based on the number of employees. Similarly, the total dividends declared by a company would be distributed among shareholders on the basis of the number of shares that are held.
When a sum of money is allocated on a pro rata basis, it means that it has been shared in a fixed proportion. To understand this concept, let us consider a car insurance policy that carries a premium of $500 for a year. What will be the pro rata insurance premium for six months? As the term of the policy has been reduced to half the original, the pro rata premium will also be calculated as 50% of $500. Hence, the pro rata premium for six months is $250.
This method can be used in many different situations. Here is another instance of the use of the pro rata method. There are two partners, A and B, who contribute the total capital of $100,000 needed for a business venture. Partner A provides $80,000, while Partner B, provides $20,000. At the end of the year, the business yields a profit of $10,000. This will be shared on a pro rata basis, with A getting $8,000 ($10,000 X $80,000/$100,000) and B getting the remaining $2,000.
Bruno buys a new computer for his office for a sum of $2,000. He also opts for a maintenance contract that covers software problems as well as hardware-related issues. This contract costs $200 and is valid for one year. Bruno is reluctant to pay an additional $200 for a maintenance contract but buys it at the insistence of the store manager. He is informed that he can cancel the contract at any time and get a pro rata refund of the maintenance contract fee.
In the next six months, Bruno does not need to call the store even once for help with his computer. He decides to terminate the maintenance contract. He sends an email to the store and promptly receives a pro rata refund of $100.
If an amount is to be distributed among various parties or to be allocated to different time periods, a pro rata system can be used. This method involves sharing the cost or expense or profit proportionately.