As the owner of a business, it’s important to understand how your regular transactions really work. Knowing the basics of payment processing helps you to avoid common issues when your clients run into technical difficulties. Unfortunately, most people simply don’t know what kind of technology is involved when it comes to debit card and credit card payments.
Today, we’re going to walk you through the basic details of using a payment processor, payment gateway, and similar tools, so you know exactly how everything works.
What is a Payment Processor?
A payment processor is the company responsible for managing the credit card or debit card transaction process. It acts as a kind of middleman between the consumer bank and the merchant, allowing information to pass back and forth.
Here’s a simple definition of the payment processor:
A company that is authorized in the processing of credit card transactions between sellers and buyers. The payment processor is often the third party and will be appointed by the merchant. There are two types of payment processor; front end and back end.
A front-end processor will have a connection to various card associations and will supply settlement services and authorization to the merchant banks’ merchants. The back end processors are used to accept the settlements from the front end processors, and to move money from the issuing bank to the merchant bank, this process being complete in just a few seconds.
These processors perform many functions such as evaluating whether transactions are valid and approved, using anti-fraud measures to assure that a purchase transaction is initiated by the source it claims to be. Processors are held to standards and regulations organized by credit card associations. These standards include rules regarding fraud, chargebacks, and identity theft.
The Basics of Payment Processors
By communicating between two banking facilities, a payment processor can determine whether there’s enough credit in an account for a transaction to happen. For businesses accepting credit card payments from groups like Mastercard and Visa, a payment processor is an essential part of the digital environment or point of sale.
There are various fees associated with your payment processor as a business owner, including chargeback fees, transaction fees, lease charges if you’re using hardware equipment for accepting payments, and so on. However, this is a necessary expense for making money with your business.
Keep in mind that payment processor isn’t a universal term, and in some cases, it’s used with other terms like acquirer. However, it is important to note that a payment processor is not the same as a payment gateway or a merchant account.
Payment Processors vs Merchant Accounts and Payment Gateways
Payment processors are only one component in the card network for companies accepting transactions. You’ll also need to understand the role of payment gateways and merchant accounts too. Let’s start by defining a payment gateway.
A payment gateway is the middlemen between third-party payment systems, merchant accounts, and the credit card or debit card companies. The software for a payment gateway handles the technical side of transferring cardholder information. If you don’t have a payment gateway, you won’t receive payments from your customers, even when all the other systems you need are in place.
Merchant accounts are a specific kind of bank account – one that accepts debit and credit card payments as a middleman between your customer and your actual bank. You’ll need a merchant account to accept payments from other cardholder customers in your network.
While merchant accounts, payment processors, and payment gateways are quite different, it’s worth noting that they are all intricately connected. As a business owner, you’ll need to have access to all these things if you want to run your store successfully.
The payment gateway will be responsible for handling the transfer process, while the payment processor authenticates your transaction and keeps it secure. The merchant account is where your bank will settle the funds before they pay into the business account.
How Does Payment Processing Work?
Even with a basic knowledge of credit card processing technology, it can be difficult to understand how the system works with various payment methods. The payments ecosystem is often quite confusing, particularly for a small business owner that’s dealing with everything from PayPal for online payments, to POS solutions for in-store American Express transactions.
If you’re still not totally sure about the things we’ve mentioned so far, don’t worry, here’s a quick step by step guide to keep you on track.
- First, the customer completes your checkout process on your website, or in-person, entering their credit card information into the appropriate terminal. They may use a variety of different cards, from discover to visa, depending on your payment system.
- The merchant will then transfer the financial information received (including cardholder details) to the payment gateway.
- After processing the transaction details, the payment gateway will pass the information along to the third-party payment provider the merchant uses.
- The payment processor then transfers transaction information to the card network via Mastercard or Visa.
- The card network will transfer information through to the bank of the customer, which checks whether there’s enough funds to complete the transaction.
- The system submits a response to the card network which highlights whether the transaction was decline or approved.
- The response goes through to the card network, which will inform the payment processor whether the transaction should take place. The processor moves the information through to the payment gateway, informing everyone of the outcome.
- Funds are then deposited by the bank of the customer into the merchant account, where they remain until they are paid into the company’s bank account.
What About Online Payment Processing?
The good news for today’s ecommerce companies is that payment processing online follows a very similar format to the brick-and-mortar process. The important thing you’ll need to remember here is that processing online requires an aggregator or merchant account. There may be some extra fees to pay depending on your shopping cart and which payment methods you accept. Online:
- Your customer makes a purchase and enters their card details
- You (the merchant) submit a credit card transaction
- Your payment gateway sends the information of the secure transaction
- The transaction, approval, and verification process go through the processor
- Your customer’s bank account sends the money to the processor
- The processor sends the gateway an approved/ denied status
- When approved, the merchant receives a payment
Leading ecommerce platforms like Shopify and BigCommerce support a host of payment processors and gateways. If you want to use the same payment processor you would use with your brick-and-mortar store, however, you may need to resort to a third-party solution. Your payment processor may not always be supported by an ecommerce platform directly.
Payment Processing Costs
Although payment processors are an essential part of running a successful business, they’re also an expense for your company. Pricing depends largely on which provider you work with, but you’ll often find that the cost also increases depending on the features you want from your payment processor. For instance, if you want more ACH payments, or a wider range of currencies to be accepted, then you’ll need to look for a more specialist solution.
To handle some of the important connections between acquiring bank accounts, and other important tools for payment processing, a payment processor charges a variety of fees. These costs differ depending on your business needs and the kind of processor you choose. You may also need to pay various interchange rates, and financial institution costs if you’re accessing merchant services alongside your payment processor. Common fees include:
- Flat fees: This is the monthly cost of using a payment processor to process payment information.
- Transaction fees: These are built on a per-transaction basis. They’re usually based on a payment processing company markup cost, the assessment fee, and the interchange fee. These components ensure that all the right people in the transaction journey get a portion of the required fees.
- Additional fees: These are additional incidental fees that might happen with payment processors like Stripe and PayPal, such as when a card data check reveals that a card account doesn’t have the right funds.
Depending on the payment processor you choose, you might find that your service provider offers a variety of pricing models to explore. Tiered models are usually the most expensive, and it’s worth noting that the amount you pay to accept credit and debit card payments might not be entirely transparent.
The more transparent option would be to use the interchange plus pricing system, which shows you a flat monthly amount that you pay on each transaction. Keep in mind that there’s more to consider than budget alone when you’re choosing the ideal payment processor.
What to Look for in a Payment Processor
Whether you find the processing fees and complexity of payment processors annoying or not, you still need one of these companies if you’re going to run a successful business. A third-party payment processor is an essential tool for accepting credit and debit card payments online. However, there’s more to think about than just the cost when making the right choice. Don’t forget:
- Customer service: If anything goes wrong with a payment processing system, then you need to get information from your provider as quickly as possible. Your payment processor should be ready to answer your call and sort through difficult transactional issues with you.
- Compatibility: If you’re already using various other forms of software to run your business, then you’ll want your payment processing solution to work well with that technology. This includes any ERP systems, as well as payment processing checkouts.
- PCI compliance and security: You’re dealing with customer details on your store, which means it’s up to you to ensure that the information remains protected and safe. PCI compliance is something that every country demands of its retailers. Make sure that your processor is fully compliant and secure.
- Fraud protection: Another aspect of security is protecting yourself and customers from fraud. Some payment processors have tools to help fight against fraud built-in as standard.
- Flexibility: Your payment processor should be able to handle a range of payment types quickly, even if you’re taking lots of payments in rapid succession. Make sure that the company has a good online review reputation before you get started.
Although you might think that you can avoid payment processor and gateway fees if you go without a payment gateway, there’s no fully reliable way to accept payments online from others, aside from asking for a bank or wire transfer. Your customers need a reliable and simple way to pay for the things they want, and a payment processor provides that.
Like any other investment in your business, the key to successfully choosing the right payment processor for small businesses or startups, is doing your research. Consider your payment options, the point-of-sale system you use, and any other technology that may affect which payment processor is right for you.