Definition: Pro rata means the proportional allocation of a given numerical figure. In other words, it is the distribution of a given amount by using pre-established percentages.
What Does Pro Rata Mean?
What is the definition of pro rata? This term comes from the latin pró ratá, which means according to the calculated share. This is a concept that sounds more complicated than it is and its application can be easily identified. In business, a pro-rata calculations are used for the purpose of allocating revenues, expenses, capital and many other financial figures to different recipients for the purpose of analysis, sorting, or distribution.
In the case of revenues, a pro rata calculation can be used to set a quota for different geographical locations, e.g. the quota for the Hollywood district will be 12.5% of last year’s sales of the Los Angeles state office. On the other hand, expenses can be set by using a pro-rata approach when a budget is being designed, e.g. marketing expenses will be limited to 5% of net revenues. Nevertheless, the most common use of pro-rata in business is the allocation of capital according to shareholders ownership, e.g. if a shareholder owns 20% of the shares of a given company that means he’s entitled to 20% of the total capital of that company.
Let’s use an example to illustrate this concept.
Heavy Loss, Inc. is a gym that provides top of the line equipment and helps their subscribers achieve their training goals. The company was started by three brothers: Tom, Dick, and Harry. Tom and Dick came up with the idea for the business and funded the operations for the first year, so their ownership percentage is slightly bigger than Harry’s. Tom and Dick both own 40 percent of the company leaving Harry a 20 percent stake ownership.
At the end of the year, Heavy Loss had a net income of $100,000. This profit is split on a pro rata share basis, according to the brothers’ ownership percentages. Thus, Tom and Dick both receive $40,000 while Harry receives $20,000 for the year.
Define Pro Rata: Pro-rata means division according to a predetermined percentage.