Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Pro Rata

What it is:

Pro rata refers to the proportional distribution of a sum across a number of units.

How it works (Example):

A Latin term meaning "in proportion," pro rata is a method of allocating fractional amounts of something equally among all parts of a whole. Where interest rates are concerned, the practice of pro rata allows a periodic interest rate to be divided into smaller units (e.g. converting an annual rate into a monthly rate). This action is called "prorating" and may be used in reference to a bond being sold at discount; to a total dividend as divided among entitled shares of stock outstanding; or to an annual insurance premium adjusted for the remaining number of months in the year following the purchase of a policy.

To illustrate, suppose company XYZ declares a $1 million cash dividend. There are currently one million entitled shares outstanding in the market. Company XYZ, therefore, prorates the dividend to $1 per share based on the following math:

$1,000,000 dividend / 1,000,000 shares outstanding = $1 dividend per share outstanding
 

Why it Matters:

The pro rata system provides a method for allocating single-unit amounts among several smaller units. This becomes particularly important for the sale and purchase of time-sensitive items such as interest-bearing securities and annual contracts or periodical subscriptions.