Credit Card Processing 101: A Necessary Evil Of Business

CREDIT CARD PROCESSING 101: A NECESSARY EVIL OF BUSINESS

More often than not, credit card processing is viewed as a necessary evil by business owners, and we get that. It’s a complex system for something that takes just seconds to work. However, as a business owner, it’s useful to understand what the system does since payment processing is one of the biggest costs a small business will encounter. So let’s break down everything, from the basics to the nitty-gritty, in order to take control of your credit card processing as a business owner.

WHAT IS CREDIT CARD PROCESSING?

In short, credit card processing is the procedure that occurs when a customer swipes or otherwise enters their credit card to pay for a transaction. In real-time, the majority of the process takes seconds. But what occurs between points A and B is intricate because, by the time a customer is picking up the pen to give the merchant their John Hancock, their payment has already been authorized and authenticated. Then it’s settled and cleared. So what happens during those four steps?

1. CREDIT CARD AUTHORIZATION

Kicking off the transaction, the authorization checks a customer’s credit card number, expiration date, billing address, security code like CBB, and payment amount. After the cardholder pays the merchant, the merchant sends the credit card information to the acquirer. Then, the acquirer forwards the details to the credit card network (Mastercard, VISA, Chase, etc.,) and the credit card network requests payment authorization from the issuing bank.

2. CREDIT CARD AUTHENTICATION

After authorizing the payment, the issuing bank verifies the credit card with fraud protection tools to ensure its authenticity. If everything checks out and the funds are available, then the issuing bank sends an approval code to the merchant via the credit card network. The merchants collect their approved transactions in a “batch” and finally, the merchant gives the customer a receipt to confirm the transaction.

3. CREDIT CARD CLEARING AND SETTLEMENT

Last but not least in the credit card process, the transaction must be settled and cleared. This step is slightly more complicated as it involves more moving parts and can take up to 24-48 hours. It begins with the “batch” of confirmed transactions, which are sent from a business to the acquirer. The acquirer sends the “batch” to the credit card network for settlement, then the credit card network sends approved transactions to the appropriate issuing bank. The funds are finally transferred to the acquirer. When this is all said and done, the credit card network pays the acquirer their percentage from the remaining funds because card processing companies take a cut of each transaction.

Oh, and we’re not done yet. The acquiring bank then has to credit the merchant’s account for the cardholder purchases with the merchant discount rate. And finally, the issuing bank posts the transaction information to the cardholder’s account where the customer receives the statement and has to pay the bill.

It’s pretty mind-blowing to know how quickly this protocol occurs, and it’s efficient despite the many steps and participants involved. That being said, let’s further examine who the participants are since we’re throwing around uncommon terms.

Credit card processing

CREDIT CARD TRANSACTION PARTICIPANTS

There are six contributors to credit card processing. First is the cardholder, or the customer, who can fall into two categories. One is a transactor who repays their credit card balance in full. The other is called a revolver, and they repay part of the balance while the rest of their transaction gains interest. Of course, there’s also the merchant. This is the store or vendor who provides the goods or services. It can take the form of an online shop, brick & mortar store, or mobile store. Their job as merchants in the credit card processing system is to send their customers’ card information to their issuing banks and request payment authorization for each transaction.

Next up is the mysterious issuing bank. They’re the financial institution that issues the credit card. Examples of credit card issuers include

  • Amex
  • Discover
  • MasterCard
  • Visa
  • Citi
  • Capital One
  • Bank of America

They also receive the payment authorization from the credit card network and then either decline or approve the transaction. There’s also the acquiring bank, otherwise known as the merchant’s bank. They receive payment authorization requests from the merchant and send them to the issuing bank. Then, they relay the issuing bank’s response to the merchant. Along with the acquiring bank is the acquiring processor. They’re a third party that acts as an extension of the acquiring bank to provide a service or device, like a chip reader, allowing merchants to accept and send payment details to the credit card network. Their last job is to forward the payment details back to the acquiring bank.

Our last player up to bat is the notorious credit card network. They operate the networks that process credit card payments and govern exchange fees. The four credit card networks are Visa, Mastercard, Chase, and American Express.

Credit Card processing image

HOW LONG DOES A CREDIT CARD PAYMENT TAKE TO PROCESS?

As we touched on earlier, the authorization and authentication process can be instantaneous or completed within a few seconds. However, after the transactions are settled it can take up to two business days for the payment to be deposited into the merchant’s bank account. Some processors provide same or next-day deposits or process credit to business owners, while some have a longer payout time period. For cardholders, the transaction will show up immediately.

HOW TO PROCESS CREDIT CARD PAYMENTS

As a business owner that accepts credit cards, you need to know how to process these payments. Thankfully, this part is done completely online. For mobile credit card processing, credit card networks require an application from merchants to accept credit card payments on mobile devices. This is a great option for new businesses, freelancers, and seasonal businesses because it saves money on the processing fee for each transaction.

Another way to process credit card payments as a business owner is with merchant credit card processing. This is a bank account that allows businesses to accept credit card payments. It essentially acts as an agreement between a retailer, the merchant’s bank, and the payment processor for the settlement of credit card transactions.

CREDIT CARD PROCESSING FEES

Now, this is the reason why you’ll see some merchants only accept cash or a minimum purchase cost before allowing credit card use. To put it plainly, credit card processing fees are a hassle for many small business owners. The rates and fees vary depending on which platform the good or service is being delivered (mobile, online, brick & mortar) and they can show up under different names. However, if you know what they are, compare them between companies, and consider what works best for your business then they’ll be manageable.

The three types of credit card processing fees are hidden, interchange, and transaction fees. A hidden fee is triggered by individual actions (usually unawareness), which merchant services make a profit out of. Transaction fees are broken down into interchange fees and cents per transaction. They’re the only mandatory fees associated with credit card processing, and their cost is set by credit card companies.

With these fees, you’re essentially paying Visa, Mastercard, Discover, and Chase for the ability to accept their cards for your business. Within that umbrella is the interchange fee. This is what the acquiring bank and processor pay the issuing bank. The fee’s cost varies based on the following

  • The processing method used
  • The credit card company
  • The card type (regular, premium, etc.)
  • The merchant’s business type

It’s good to stay up to date on the fee rates since they change periodically. For example, Visa and Mastercard update their interchange rates twice per year.

To gauge what the fees look like, average credit card processing fees are based on the percent of each transaction (between 1.3 to 3.4% of each transaction.) According to the chart below, the lowest credit card processing fees are through Visa with 1.29% + $0.50 to 2.54% + $0.10.

Chart of average credit card processing fees. Courtesy of

Chart courtesy of The Ascent. https://www.fool.com/the-ascen...

Other credit card processing fees include

  • Assessment fees
  • Equipment fees for merchants that accept in-person transactions
  • Subscription fees

BEST CREDIT CARD PROCESSING COMPANIES

WHICH CREDIT CARD PROCESSING COMPANY TO CHOOSE

Navigating business as an owner involves plenty of moving parts and decision-making. One of those decisions is choosing a credit card processing company. For your research, start by looking and comparing a company’s month-to-month terms, interchange-plus pricing, and other features such as how you plan on accepting payments, processing equipment, and hidden fees. Make the company’s interchange fee a top priority since it’s one of the biggest cost components for a business.

Examples of popular credit card processing companies include:

  • Square credit
  • Quickbooks
  • Stripe Credit
  • PayPal
  • Paylive Data
  • Flagship merchant services
  • Heartland
  • Intuit
  • Costco

CREDIT CARD PROCESSING COMPARISON CHART

When it comes to deciding which credit card processing company to use, you should compare and contrast their prices. However, the best way to compare isn’t with the merchant service’s charts because they’re biased and prices can be manipulated since the fees change frequently based on the market.

An effective way to compare is with a chart like the one below, which looks at five types of processors and explains why it’s the best choice for a certain business.

Chart for best credit card processing broken down to small business overall to online.

Chart courtesy of Ben Dwyer from CardFellow https://www.cardfellow.com/blo...

CREDIT CARD PROCESSING FOR SMALL BUSINESS

HOW CAN A SMALL BUSINESS ACCEPT CREDIT CARDS?

One of three ways: online, mobile, or with merchant getaway. This requires the cardholder to swipe, tap on their phone, or manually enter their credit card information. The cheapest way to accept credit cards is at brick and mortar stores since processors charge more per online and mobile transaction.

WHICH CREDIT CARD PROCESSING COMPANY IS CHEAPEST FOR SMALL BUSINESSES?

According to U.S. News, Payment Depot, Fattmerchant, Helcim, Square, and Dharma Merchant Services are the best credit card processors for small businesses. This was determined based on multiple factors including,

  • Pricing structure
  • POS system, which is software like terminals and cash register card readers
  • No hidden fees
  • Customer service
  • EMV-compliant, which means they process chip credit cards
  • PCI-compliant, which is the Payment Card Industry Data Security Standard

BEST RATES FOR CREDIT CARD PROCESSING

As you can tell from this data, small business owners can expect to pay $20-$99 for monthly subscriptions but not all credit card processors charge small businesses a monthly fee. Square is one option that doesn’t have a monthly fee.

Additionally, as a rule of thumb, payment processors charge more for keyed and online transactions so online businesses can expect higher rates than strictly brick and mortar merchants. Also, look at the average cost per transaction because some credit card processors might have a cheap transaction fee for small purchases, but the highest transaction rates for bigger purchases. The chart below details how a credit card processor like Shopify is suited for small businesses like coffee shops, where most transactions are around $5.

Now that we’ve gone through credit card processing from top to bottom, which credit card processing company is your favorite?

Which credit card processing company do you currently use?

How did you choose your credit card processing company?

And will you change your credit card processing company after reading our guide? Let us know in the comments below!

Thanks for reading! Check out our other blogs here to find out more about who we are and what we write about!

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