Last Updated on
If you want to accept payments for your small business or e-commerce company, you might be overwhelmed by the amount of information when it comes to payment processing. How is such a seemingly simple process –moving money from Point A to Point B– so complex?
In this article, we aim to demystify the process by outlining all the factors involved. You can jump ahead to:
- Understand different fee structures
- Learn how payment processing works
- Learn how merchants integrate payment processing
- Explore how payment processing companies handle fraud
Important Terms to Know in Payment Processing
Knowing the following terms will help you to better understand payment processing and make it easier to choose a provider for your small business.
- Checkout: Term used to indicate when someone is ready to place a transaction.
- Point of Sale (POS): The time and location where a transaction takes place. This is the point where the merchant calculates the total and tells the customer how much they owe. POS system refers to the hardware and software used to handle the transaction.
- PCI Compliance: Payment Card Industry security measures that must be met for a merchant to accept credit cards. Outlines requirements for how information is stored, processed and transmitted to ensure a secure environment for credit card numbers and other sensitive information.
- Merchant accounts vs. Merchant services: A merchant account is where payments from a customer’s card go, while merchant services are the companies that provide these accounts and may include additional services such as NFC/RFID services.
- Chargebacks: A forced transaction reversal usually initiated by the consumer due to fraud or failure to deliver goods. This pulls the money out of the merchant account and returns it to the customer’s card or account.
- Wholesale Fees: Processing fees set by the credit card companies, these are non-negotiable and passed on to the merchant through the payment processor.
- Retail or Markup Fees: These are the fees payment processors charge, which is sometimes negotiable. May include flat fees, transaction fees, and equipment fees.
- Virtual terminals: A software application that allows merchants to manually enter the credit card information, and thus accept payments without a card reader.
What is Payment Processing?
Payment processing is a third-party tool or app that handles the movement of information and money from the purchaser to the merchant. At its simplest, a payment processor functions as a bridge between the merchant and the buyer’s bank account.
Depending on the type of payment, this process might also include a credit card network, a payment gateway, and a merchant account. Here’s how they differ:
- Credit Card Network: Tells the payment processor if the card number is valid and if funds are available.
- Payment Gateway: Software that connects to processors and allows your business to accept business’ payments online.
- Merchant Account: An account created with your payment processor to allow you to accept credit/debit cards and transfers payments to your business bank account.
What Kind of Businesses Use Payment Processing?
Most businesses use payment processors to accept payments from customers. This includes all business sizes — online and offline — from the stall at your local farmer’s market to large, global enterprises like Target.
In many cases, the age of your business and its cash flow will not impact your business’ ability to use a payment processor. However, it may impact the fees you pay.
Getting a merchant account (which is a critical part of payment processing) may require providing information such as financial statements and processing history to ensure your business is low-risk. Smaller and newer businesses may have to jump through additional hoops to secure a merchant account.
Popular Payment Processing Providers
If you already know about fee structures and processes, take a look at these three popular payment processing options. We listed some useful features and payment fees. If you are unfamiliar with how payment processing works, you should have a better idea as to which provider is best suited for your business by the end of the post.
Square was founded in 2009. It is a payment processing provider that provides both software and hardware payment options. In 2018, Square reported a gross payment volume of $84.65bn.
Fees and Pricing:
- Per swipe: 2.6% +10¢
- Invoices and e-commerce: 2.9% + 30¢ per transaction
- Virtual Terminal: 3.5% + 15¢ per transaction
- Accepts magstripe, chip card, NFC, or keyed in payments
- Doesn’t require a wifi or phone signal
- Free signup, no long contracts
- Seller fraud protection
Stripe was also founded in 2009. They offer a payment processing software solution that is integratable to accept physical payments on mobile devices and tablets.
Fees and Pricing:
- Pay-as-you-go: 2.9% + 30¢ per charge
- Other options: Customizable and blended pricing
- Works with open source website CMS systems
- Includes invoicing
- Rigorous security compliance
- Hundreds of software and hardware integrations
Fees and Pricing:
- Swiped: 2.7% per transaction
- Keyed: 3.5% + $0.15 per transaction
- International: 2.7% per swipe plus a 1.5% cross-border fee plus 2.5% currency conversion
- Accepts all cards, PayPal, and in-person payments
- Includes invoicing
- Seller fraud protection
- Accept payments through your website
How Does Payment Processing Work?
Your customer orders an item from your business, swipes their card — then what happens? That is when the payment processor comes in.
Here is how the money gets from your customer’s account to yours:
- Your customer finds an item they like and brings it to the register or adds it to their online cart
- The customer swipes their card to make a payment
- The payment processor encrypts the transaction data and reaches out to the credit card company
- The card issuer checks the customer’s account and sends back an approval or a denial to your payment processor
- Your payment processor returns the approval or denial
- Funds are sent from the customer’s card to your merchant account
- Your merchant account sends the funds to your business bank account
If it seems like a complex process, that is because it is! Especially since it all happens in the blink of an eye.
Participants in Payment Processing
Depending on the payment processor you use and the type of payment, there can be six or more participants in this process. Here is what you need to know about each one.
- Credit card companies: Visa, MasterCard, American Express, etc. These are the companies that issue credit cards, set credit limits, and accept payments from customers for charged purchases.
- Issuing banks: The banks that issue credit and debit cards such as Wells Fargo, Citi Bank, and USAA. Some credit cards companies are both the credit card company and the issuing bank, such as American Express.
- Acquiring banks: Also called credit card processors, these participants act as a go-between from the merchant and credit card companies.
- Payment processors: The software that verifies accounts and passes information from the customer’s bank or credit card to your bank or merchant account.
- Payment gateways: Software that sends transactions to the acquiring bank, most often used in online payments.
- Merchant account providers: The bank or institution that holds the money from customer’s credit card payments and transfers that money to a business bank account.
Payment Types & Locales
There is a wide range of payment types that may be accepted by merchants. When choosing a payment processor, ensure they work with the most common types of payments your customers use and cover the locations where they use them.
Examples of payment types include:
- Credit card
- Debit card
- Cryptocurrencies (like Bitcoin)
- ACH (automated clearing house)
- Funds transfers
- B2B invoice payments
- Mobile wallets like Apple, Google, Samsung
Payment Processing Technology
At its core, payment processing technology is the software that allows your business to process transactions with customers. Payment processing software and hardware encrypt, verify, and process payments.
Payment processing is complex, which can make finding the right solution difficult. When comparing options, look carefully at the pricing model and compare the wholesale pricing (what the credit cards charge) versus the markup fees, which are the fees payment processors charges.
Here are the most common pricing models and what they mean.
- Membership: Charges a monthly membership fee and a small per-transaction fee, rather than a percentage of each transaction.
- Tiered: This model can be complex. Pricing varies based on the type of credit card transaction being processed, with merchants often paying a lower fee for swiped card versus a manually entered card.
- Flat-rate: All transactions cost the same, no matter what. Sounds good, but the rates are often very high for higher volume stores. Maybe a better choice for low volume businesses.
- Interchange-Plus: Despite its name, it’s one of the most transparent pricing models. It includes the cost from the credit card (wholesale) plus a mark up from the card processor and makes it clear which rate is which.
- Blended: Pricing structure that blends the wholesale cost and the processor’s markup rate. This structure makes it difficult to compare pricing.
Understanding Payment Processing Costs
The variety of pricing structures can make it difficult to understand which processors are more affordable. This section will help you understand the different costs and what they mean for your business.
The most common types of payment processing fees include:
- Transaction fees: A fee based on a percentage of the transaction total.
- Scheduled Fees: Flat fees charged every month, which may include membership fees or monthly fees
- Incidental Fees: Fees charged per event, for example, you might see a fee for a chargeback.
- Wholesale Fees: The fees charged by credit cards to the merchants. These should be the same for every processor.
- Retail/ Markup Fees: The fees charged by the payment processor in addition to the wholesale fees.
- Equipment Fees: Fees charged for hardware, such as POS systems, card swipers, etc.
How Can You Compare Costs Across Services?
To best understand how to compare costs, you need to break down all the different fees.
Just because one processes offers a free card swiper and lower transaction fees doesn’t mean it is the best choice for your business. Transaction limits may also bump your business into a higher pay structure if you exceed their limits.
You can also use historical transaction data from your business to ask payment processing vendors to estimate how much they’d charge and use the pricing to compare with other vendors.
Integrating Payments With Your Business
Payment processors help you to physically accept payments– but how do you track sales, send invoices, and handle the rest of the bookkeeping process? If you already use a system like QuickBooks to send invoices, then look for a payment processor that will integrate with your current software.
Zoho and Xero are other popular account software options that may integrate with your payment processor. Service-based companies may consider using a platform like FreshBooks to track invoices and sales.
Many POS systems also offer invoice or order creation capabilities as well as sales reports and other data to help you understand how well your company is doing.
Adding Payment Processing to Your Website
Adding payment processing to your website might seem complex based on all the information above, but the rise in technology has made it easier than ever to add payment processing to your website.
For small or online businesses, these platforms are an easy way to start accepting payments today. However, consider factors such as fees, payment types, and integration options when selecting the right provider.
Is Point of Sale (POS) Equipment Included?
POS equipment includes physical items such as a credit card reader, bar code scanner, cash register, printer, tablets, change drawer, and any other physical equipment used to process a payment with a customer. Many payment processors offer this equipment, but most charge a fee.
Before deciding on a processor, consider whether the equipment must be purchased outright, leased, or if the processor offers a payment plan. Some processors, like Stripe, provide a small card-reader that works with smartphones free of charge.
How Payment Processing Services Handle Fraud
Fraud is a big deal when it comes to online sales. After all, anyone can use a credit card online, if they gain access to the account number, CCV code, and expiration date. Credit card companies have taken charge by instituting PCI compliance, which is a set of standards laid out by the credit card industry itself.
Other fraud prevention features include:
- Address Verification: Verifies the customer’s billing address when processing a credit card.
- Dual Authentication: Usually set up on the customer side, this requires a unique code (often sent to a mobile device) for each transaction.
- Risk Scoring: A statistical model used to catch fraudulent activities based on a variety of factors, including an overseas IP address, larger than a normal transaction, or incorrect billing address. If a transaction fails, merchants can block the order to prevent fraud.
If a fraudulent transaction does occur, it may result in a very unhappy customer and chargeback, which can cost you money. Ensuring your customers’ information is secure should be a top priority for any payment processor–and for your business.
Payment Processing FAQs
Here are answers to some of our most-asked questions about payment processing.
How do payment processors make money?
The short answer is fees. Most payment processing services charge per-transaction fees that can be either a percentage of the transaction’s total, a flat fee, or both. Some services also charge subscription fees, equipment leasing fees, or chargeback fees. There can also be other fees. Some fees can be negotiated but some, like fees charged by wholesale companies, are fixed.
What does the merchant need to pay upfront for a payment processing system?
In most cases you pay nothing. Leasing the hardware from a payment processor is usually covered by the transaction fees. For example, Square, Stripe, and PayPal have no setup fees. However, other companies may charge a deposit fee or require that you purchase your own equipment.
Do preferred payment processing methods vary by industry?
The good news is that most popular payment processors can be adapted to any industry. Stripe, for example, will build a custom user interface (UI) that works best for your industry. You can also find specialized processors like InstaMed for medical businesses or Vagaro for the fitness industry.
How can I accept credit cards on my smartphone?
Typically a payment processor will give you a magnetic stripe and chip reader that you can attach to your phone via one of its input ports. You can use either an Android app or an iOS app to work in conjunction with the reader.
What is a merchant account and how is that different than payment gateway?
A merchant account is a deposit account (like a checking account) that temporarily holds the money you get from customers. You can access this account to transfer money into your business checking account. A payment gateway is a piece of software that interfaces between banks and your payment processor to complete transactions.
Do I need a merchant account to accept credit cards?
Yes, but most payment processors will provide a merchant account for their customers. You then can transfer money in the merchant account to your business checking account.
How do I accept international payments?
Many payment processing companies allow you to accept international payments, often with an additional fee. If your business does a large percentage of its transactions with foreign countries, make sure your payment processor can handle them before you commit. If you plan to accept international payments in the future, make sure you can add them on later.
Is there a difference between debit card and credit card transactions?
A debit card transaction pulls money from a customer’s checking account like a check. Credit card transactions are funded via a line of credit (like MasterCard or Visa) from a bank. Some payment processors charge more for debit card transactions since credit cards are less risky and don’t involve the possibility of a bounced check.
Do I need a cash register to take payments?
Not necessarily. If you already use a cash register, make sure to ask if your payment processing vendor can incorporate it. If you don’t have one but would like to get a register, many payment processors can include this with the hardware the sell or loan you.
Can payment processors work with cash transactions?
Yes, many of them can. For example, Square allows you to simply choose “cash” on the transaction type and enter the amount yourself. On the other hand, although PayPal doesn’t have a cash option, it lets customers pay via their own PayPal account.
Is payment processing easier with an Apple or an Android smartphone/tablet?
Most payment processors can work with either mobile operating system — Android or iOS — and provide apps for both. “Easier” really comes down to which system you’re more familiar with. It’s best to choose your favorite operating system so that there’s a lesser learning curve.
There’s no doubt about it — payment processing is complex. We hope this page has clarified the process and armed you with the information you need to make a sound decision. Still have questions? Leave us a comment below!