Payment processing practices involve streamlined communications between you, the merchant, your bank, the customer’s payment source, and their bank. Whenever a customer wants to make a purchase using a credit or debit card for example, they must disclose sensitive data that is to be communicated to the various components of the funds transfer procedure.
Choosing the payment processing company providing this service should be done with care after ensuring that the one you select possesses the full set of features that will best address the unique needs of your business.
This article will outline the definition of payment processing, how it works, the features you should focus upon when partnering with a payment processing provider, and the related fees you can expect to pay.
What is payment processing?
Payment processing is the secure transfer of funds between a buyer and a seller, typically involving the authorization, verification, and settlement of electronic transactions.
All of these steps are facilitated by a payment processing provider or acquirer. This company ensures that the funds are coming from a legitimate source, screens for fraud and other anomalies, ensures that there are sufficient funds, and takes all necessary actions to move the money from buyer to seller.
In essence, the payment processor makes it possible for electronic payments to flow seamlessly and quickly, forming the backbone of today’s digital payments ecosystem.
Common types of transactions.
Payment transactions come in a variety of forms, each uniquely designed to meet buyers’ neeeds and preferences. The most common include the following:
- Debit cards. Directly linked to a customer’s bank accounts, they allow funds to be transferred immediately.
- Credit cards. Since these offer a set line of credit, customers can make a purchase now and pay for it incrementally over time.
- Electronic funds transfer (EFT). Funds can be automatically withdrawn from a credit card or bank account according to a predetermined agreement.
- Automated clearing house (ACH) transfers. This bank-to-bank arrangement allows for efficient funds transfers, often for recurring payments. Learn more about the differences between EFT vs ACH here.
- Digital wallets. Using vendors such as Apple Pay, Google Pay, and Samsung Pay, this method involves the storage of customers’ payment details on their mobile phones in a secure digital repository. At the time of purchase, contactless funds transfers can occur safely thanks to robust identity verification and secure data transfer protocols.
- Mobile payments. These occur when funds transfers take place between a customer’s smartphone or wearable device and the merchant’s compatible reader. Tokenization and encryption help to keep the data secure as information is sent to and from the card network.
How payment processing works: transaction life cycle.
Payment processing operates by moving a customer’s money from their payment source to yours.
Transaction initiation.
It all begins with the cardholder deciding to make a purchase and initiating the transaction. This can happen in person by swiping, inserting, or tapping their device or credit card at a point of sale or POS system terminal.
Alternatively, they can enter card details on a website or mobile app or use a digital wallet.
Data transmission.
After the information to accept credit and debit card payments is entered by the customer, the data is securely transmitted by the point of sale terminal or payment gateway. This is typically accomplished using encryption.
Authorization request.
Payment data is forwarded to the payment processor by the merchant’s payment gateway. When necessary, the authorization request is then sent by the processor to the appropriate card network, e.g. Visa, Mastercard, Discover, etc. Afterwards, the information is transmitted to the customer’s bank.
Authorization approval or decline.
Once the customer’s bank receives the request, they verify the customer’s account. They also check to be sure that there are sufficient funds or available credit. Finally, stringent security measures are implemented to guard against all types of fraud.
The bank then approves or declines the payment, sending a response back to the payment processor, who then relays it to the merchant.
Transaction completion.
If the transaction goes through successfully, the seller can now complete the sale. In the event that it is declined, the seller informs the customer.
Settlement.
Funds can now be transferred from the customer’s issuing bank to the merchant’s acquiring bank. Generally, settlement occurs in batches at the end of the day, with settlement completed usually within three business days.
Common ways to process payments.
One of the features that makes credit cards so attractive is their flexibility. This form of electronic payment can be accepted in a variety of secure and convenient ways to match customers’ varying needs.
Keep in mind that, regardless of what types of payments are to be processed, a business must first find a payment processing provider and have some sort of account into which funds can be deposited, before transfer to the regular business account after settlement.
Online.
In order to accept online payments, you need a specific infrastructure to take credit and debit cards, as well as other digital payments. First, you must have a digital storefront where you display information about your products and services and accept purchases. This could be a dedicated website or a shop on an external marketplace.
You also need a payment gateway that facilitates payments from the time information is inputted by the customer, until the transaction is declined or completed.
The third crucial element is the payment processing provider, who collects payment information and communicates with the other players in the payment process to facilitate a smooth transfer of funds.
In-person.
To accept payments when face-to-face with a customer, you need a POS system and, in most cases, a card reader to gather the payment details. These could be swiped, tapped, or contactless.
The particular hardware you choose, i.e., a countertop terminal, tablet, or smartphone, will depend on your customer’s preferences and your business needs.
Your payment processing company can assist you in determining what hardware and software will be most effective in helping you meet your goals and serving your customers by making in-person payments.
Over the phone.
With particular business types and situations, you may need to take orders or payments over the phone. In these instances, you manually key in the payment details provided by your customers in order to fulfill a mail order, pay for an upcoming delivery, or for any other relevant reason.
For these scenarios, a credit card processing company can give you access to a virtual terminal. This online application acts like your standard POS system reader and is configured to communicate directly with the processing company so that funds can be transferred efficiently and securely.
Recurring invoices.
There are times when it is more practical to send bills on a regular basis instead of requiring the full amount all at once. Subscription programs, memberships, ongoing services such as utilities, and paying for big-ticket items are all cases that can benefit from the recurring billing pricing model.
As long as you provide transparency and full disclosure about terms and conditions and customer responsibilities when it comes to late payments and account terminations, you can look forward to predictability, fewer late payments, and a smoother and richer relationship with your customers once you set up recurring billing.
What is a payment processor?
A payment processor is an entity that manages the transfer of funds between buyer and seller, including all aspects of data transmission, authorization request, approval or decline, transaction completion, and settlement.
Think of the payment processor as an efficient manager whose job is to expedite efficient and effective communication among all participants in the payment process from start to finish. Given the importance of its role, it is vital to devote time and energy to choosing the one that is best for your business.
What is a payment gateway?
A payment gateway is a service that authorizes credit card or direct payment processing, ensuring security and accuracy throughout the transaction. Its main functions are to encrypt the sensitive data of each transaction, verify authenticity, and ensure that the process is secure.
At the time of data delivery, the customer’s card is charged, with the funds being immediately transferred to the merchant’s account – minus fees, of course.
Features of the best payment processing companies, and how to choose one.
Picking the right payment processor is one of the most important business decisions you will ever make. There are several factors to keep in mind as you evaluate your options:
- Security. Select a processor with a proven track record of fast, secure payment processing. Your processor should protect all data being stored, managed, or transmitted with robust encryption and tokenization protocols.
- PCI compliance. Adhering to the Payment Card Industry Security Standards Council’s requirements is mandatory. Failure to do so can result in significant penalties as well as reputational loss. Be sure that the company you choose handles the payment card industry data security standard with the attention it deserves.
- Fraud prevention. In addition to complying with PCI standards, require that your system features up-to-date fraud prevention and security measures. These should include Address Verification Service (AVS), CVV checks, 3D Secure (3DS) authentication, IP address verification, and software that monitors transactions.
- Transparency. Although processing is intricate, the price you pay for it should be clear, concise, and complete.
- Choice. Your processor should give you everything you need to take payments via various channels. These should include recurring payments, invoicing, and mobile billing.
- Premium customer support. Time is money, and business interruptions due to technical glitches or equipment problems can be costly to your bottom line as well as your brand reputation. Therefore, find a provider who offers customer service via various channels, i.e., by phone, email, live chat, user forums, online knowledge bases, etc.
- Scalability. Only partner with a processing company that has the ability and resources to grow with your business. After all, payment preferences and types evolve with time and shopping behaviors.
Understanding credit card processing fees.
It should go without saying that, in order for businesses to accept credit card payments, there will be added costs and fees. This is how processing companies mitigate their risk and make a profit. In most cases, these fees usually fall between 2%-4% of the gross volume.
It is important to recognize that there are several types of fees, some of which are negotiable and others that are set by credit card companies and cannot be modified.
Interchange fees.
These fixed fees are collected by issuing banks for each credit card transaction you process. The rates are set by the card companies.
Several elements combine to go into the interchange fee. The swipe fee is typically a percentage of the transaction plus a flat rate. It can vary according to what type of card is being used and whether it is swiped or manually entered.
The assessment fee is calculated according to your monthly sales for each credit card brand. It is paid to the credit card companies separately.
Payment processor’s fees.
Processing companies also charge several types of fees to make a profit, limit risk, and cover their own expenses. Markup fees are generally charged for every transaction to achieve these goals.
Customer’s fees.
All businesses that accept credit cards will experience chargebacks. These occur when a customer disputes your charge on their credit card bill directly with their bank or card company, without attempting to resolve the issue with you first.
While a few chargebacks are inevitable, having too many can lead to added costs in time and resources for you and your payment processing company.
Should your business be hit with an overabundance of chargebacks, your provider might charge you additional fees to mitigate these difficulties.
Types of payment processing pricing models.
In addition to learning about the various fees you will be expected to pay, you also need to understand the three main pricing models that dictate what you will pay to your processing company.
Tiered.
In this model, each transaction that you process is classified as qualified, mid-qualified, or non-qualified, with each designation carrying its own unique fees. Although this model can be customized to meet your business’s unique needs, it can be complicated and confusing.
Flat rate.
This much simpler system requires you to pay the same fixed fee for all transactions, including the interchange fee. This arrangement is particularly appealing to businesses with low credit card sales volumes.
Although the monthly fee is usually quite affordable, the per-transaction cost is usually higher than you would see with other pricing models.
Cost plus.
Also called interchange-plus pricing, this model gives you an itemized breakdown of every transaction fee you pay. With this transparent arrangement, you will see exactly what you will need to shell out for the interchange rate as well as the processor’s markup.
You may even pay a monthly subscription fee. With every transaction you process per month with this model, you will save more money on fees.
North is a leading financial technology company that builds innovative, frictionless end-to-end payment solutions designed to simplify and grow businesses of all sizes. From the front door, to the back office, the developer world, and partnerships that expand the payments landscape, North offers proactive, comprehensive merchant services, in-house processing, and more.
