Merchant processing isn’t the flashiest part of running a business, but it’s one of the most important. It’s what makes it possible to accept cards, send funds, and keep your cash flow steady.
That’s why it’s key to understand how merchant processing works and which service providers will help you streamline payment processing and save you money.
In this article, we’ll break down how merchant processing works, who’s involved in every transaction, and what to look for in a reliable payment partner.
What is merchant processing?
Merchant processing is how businesses accept and move money from a customer’s card to their own bank account. It covers everything from the moment a card is swiped to when the funds actually land in your account.
Entities involved in credit card processing
To better understand merchant processing, it helps to see who’s involved in moving money from your customer’s card to your bank account.
A typical credit card processing (or payment processing) transaction involves several entities. The transaction may take place at a brick-and-mortar business or via an ecommerce or mobile interface. Regardless of the point-of-sale (or POS) platform, these entities cooperate to smoothly execute customers’ payment card transactions.
Cardholder: This is the customer using a Visa, Mastercard, American Express, or Discover EMV or gift card to make the purchase. Contactless payments and digital wallets like Apple Pay are also seeing increasingly wide use.
Merchant: This small business owner sells the product or service the customer wants to buy. The purchase can take place onsite, online, or via mobile phone.
Payment gateway: An electronic payments corridor that links the merchant to their payment processor. A payment gateway is essential for completing an online credit card or debit card transaction.
Payment processor: The entity that enables electronic communication between the merchant, the cardholder’s bank, and the credit card network.
Credit card network: This entity is also called the credit card brand or card association. The four major card networks set the interchange fee and payment card industry data security standard (or PCI DSS). Merchants are expected to meet PCI compliance standards designed to protect customers’ sensitive data.
Issuing bank: Also called the issuer or cardholder’s bank, this financial institution sends the customer their credit card. During credit card transactions, the issuing bank determines whether the cardholder has sufficient credit available.
Acquiring bank: Also called the merchant bank, this entity holds the merchant’s sales transaction proceeds. The acquiring bank also provides the merchant with a card reader and other equipment to process transactions.
How merchant processing works
A lot of things happen during those few seconds that a customer pays with their card. The money doesn’t just appear in your account; it travels through a network of banks, processors, and payment gateways that all play a part.
Here’s a step-by-step look at what happens behind the scenes of merchant processing.
1. The customer initiates the payment
It starts at checkout. The customer swipes, dips, taps, or enters their card information online. Whether it’s through a physical card reader or an ecommerce checkout form, that payment data needs to be securely transmitted to kick off the transaction.
2. The payment gateway encrypts and sends the data
Next, the payment gateway encrypts sensitive card details and passes them to the payment processor. For online businesses, the gateway is what connects your website or app to the broader payment network.
3. The payment processor routes the request
The processor then sends the transaction request to the card network (i.e., Visa, Mastercard, Discover, or American Express). The card network contacts the customer’s issuing bank to confirm if the card is valid and if enough funds or credit are available.
4. The issuing bank authorizes (or declines) the payment
The issuing bank quickly reviews the request. If everything checks out—card valid, funds available, no signs of fraud—the bank authorizes the payment. If something’s off (like insufficient funds or suspicious activity), it declines the transaction and sends a message back through the network.
5. Authorization reaches the merchant
That approval or decline message travels back the same route it came: from the issuing bank, through the card network, to the processor, and finally to your point-of-sale system or online checkout. If approved, you’ll see a confirmation instantly, and that’s when your customer’s receipt prints or their “order confirmed” screen appears.
6. Settlement and funding
Even though the transaction was authorized, the money hasn’t hit your account yet. At the end of the business day (or at a set interval you choose), your processor batches all completed transactions and sends them to your acquiring bank for settlement. The funds are then transferred from the issuing bank to your merchant account—usually within one to two business days.
7. Fees and reconciliation
As part of settlement, the various players, including card networks, processors, and banks, each take a small cut in the form of interchange, assessment, and processing fees. What’s left is deposited into your account. From there, you can reconcile payments, track sales, and keep cash flow steady.
Merchant processing technology: What tools do you need to process payments?
Modern merchant processing relies on a mix of hardware and software to power transactions. Whether those transactions take place in-store, online, or on the go, you need the right tools to be able to accept payments in a fast and secure way.
Consider the following.
1. Point-of-sale (POS) system
A point-of-sale (POS) system is the heart of in-person payment processing. It’s where you ring up sales, process card payments, and manage customer transactions all in one place. For retail businesses, this often includes a touchscreen register, barcode scanner, and card reader that can accept debit cards, credit cards, and contactless payments like Apple Pay or Google Pay.
Modern POS systems don’t just process payments; they help track inventory, monitor sales trends, and connect to your merchant account for real-time reporting. Many merchant service providers also include built-in PCI compliance features to help protect customer data.
2. Card reader or mobile payment device
If you sell at events, pop-ups, or on the go, you’ll need a mobile card reader that works with select mobile devices. These devices connect to your smartphone or tablet and let you accept credit cards and debit cards anywhere. Some providers offer custom pricing or bundle hardware into your merchant services agreement, so you can start processing payments without an extra cost or long-term contract.
3. Payment gateway for online payments
Running an ecommerce store? You’ll need a payment gateway, which is the digital bridge that securely connects your website to the payment processor. It encrypts sensitive card data so you can accept online payments safely. A reliable gateway supports multiple payment options and currencies, helping your business reach customers in other countries and expand faster. Look for transparent pricing with no hidden fees, especially if your processing volume changes month to month.
4. Merchant account and business bank account
Every transaction needs a place to land. A merchant account is the holding account where funds from your sales are deposited before being transferred to your business’s checking account. Some merchant service providers bundle both your merchant account and gateway into a single payment solution, making it easier to manage settlements and stay on top of cash flow.
If you already have a business bank account, make sure it’s linked correctly so you get paid fast—usually within one business day.
5. Software integrations and analytics tools
Finally, round out your setup with software integrations that improve the customer experience and simplify your back office. Tools like automated invoicing, recurring billing, and customer engagement dashboards help you see which products sell best, when to restock, and how payments flow through your business.
A note on merchant processing technologies: The right payment processing solution depends on several factors, including where and how you do business, as well as what your customers expect. Not every business needs a full POS setup—if you sell exclusively online, for instance, a secure payment gateway might be all you need.
All that said, at the very minimum, every business that wants to accept payments should have a reliable merchant account, payment processor, and PCI-compliant system to keep transactions safe.
What products/services do merchant service providers offer?
A merchant service provider serves as a bridge between merchants and the banks that process card transactions. The following types of businesses may play the role of a merchant service provider:
- Bank (or other financial institution)
- Independent sales organization (or ISO)
- Electronic payment gateway provider
They offer diverse products and processing services to help merchants meet their card processing needs. Today, merchant service providers frequently offer gift cards and loyalty programs as well. Some of their most common product/service offerings include:
- Point-of-sale system: Equipment that accepts onsite payments and offers other services.
- Credit card terminal: A small device that enables the acceptance of card-present payments.
- Card reader: A tiny device that enables card processing via a mobile phone or tablet.
- Electronic payment gateway: Essential for ecommerce payment acceptance.
- Ecommerce platform software: Essential for operating an online retail outlet.
- Customer support: For when you need help if issues arise.
How to select the right merchant service providers for your small business
Choosing a merchant service provider shouldn’t be a spur-of-the-moment decision. When evaluating vendors, business owners should select the provider based on multiple criteria. Merchants should opt for a provider that represents the best overall fit for the business. Let’s take a look at some of the criteria you should use to evaluate providers.
1. Payment types supported
A forward-thinking merchant service provider offers a full menu of payment options. Merchants should be able to process credit card transactions and debit card transactions. Next, business owners should be able to accept contactless payments and digital wallet payments. Customers should also be able to make Automated Clearing House (or ACH), PayPal, and traditional check payments.
2. Payment processing equipment
When it comes to payment equipment, one size definitely doesn’t fit all. Compare what each merchant service provider offers and make sure it matches how you actually run your business. Check whether they sell the hardware or include it in a promotional bundle, and see if they can reprogram your existing terminals to work with their system. And skip the leasing option—it usually costs more in the long run than simply buying your hardware outright.
3. Ease of use
With basic instructions, even first-time users should be able to process payments via a POS system or card reader. That’s why you should choose a merchant service provider that offers intuitive tools. And if they have a library of video tutorials and/or other reference materials, that’s even better.
4. Transaction security and fraud protection
Business owners should choose a PCI-compliant merchant service provider. For card present transactions, the provider should offer POS systems that accept more secure EMV (or chip) cards. EMV-based credit card payments utilize encrypted data, making the transactions less accessible to scammers. Finally, the provider should institute measures to protect against fraudulent credit card transactions.
5. Contract provisions
Many payment processing service providers place merchants into extended service contracts. A three-year contract is fairly typical, though some providers may offer month-to-month services. Merchants who exit the agreement early pay stiff early termination fees. With negative merchant feedback, some providers now offer merchants a month-to-month agreement.
6. Pricing structure
Merchant service providers typically offer one of four basic pricing models. Business owners should choose the pricing structure that fits their transaction volume and overall business needs.
Interchange-plus pricing
The transparent interchange-plus pricing model is popular with many small businesses. Here, each transaction amount is separated into the card network’s interchange rate and the payment processor’s markup fee.
Flat rate pricing
In this pricing model, the merchant pays a flat rate regardless of the customer’s card type. However, this easy-to-understand pricing model may not offer the lowest transaction processing costs.
Tiered pricing
The tiered pricing model separates transactions into qualified, mid-qualified, and non-qualified categories. Several murky factors can cause transactions to be downgraded to higher-priced tiers. Merchants should steer clear of tiered pricing models.
Membership-based Pricing
In this subscription pricing model, the merchant is assessed a monthly membership fee but pays lower transaction fees. Stax’s popular membership-based model offers wholesale interchange-plus rates.
7. Account fees
In addition to transaction fees, merchant service providers typically charge merchants a host of other account services fees. Common payment service fees include:
- Account setup fee
- Statement fee
- Monthly minimum fee
- Equipment leasing fee
- Payment gateway fee
- Batch processing fee
- PCI compliance fee
- PCI non-compliance fee
- Chargeback fee (for disputed transactions)
- Early termination fee (for contract cancellations)
8. Customer support
A reputable merchant service provider should offer knowledgeable customer support and tech support. Ideally, the provider should feature 24/7 support via phone, email, and chat. Some providers may promote good customer support while outsourcing services to less-informed contractors during non-business hours.
9. Software integrations with popular third-party apps
Merchants should consider whether a merchant service provider’s program integrates with the merchant’s business operations software. Common software programs include accounting, business banking, financial services, and customer relationship management systems. In addition, the provider should ideally support integration with popular third-party apps.
10. Business scalability
Many merchants plan to gradually scale their businesses. Companies may grow their product or service offerings, enter new markets, or both. In any case, the merchant service providers should be able to support that growth with no operational hiccups.
Selecting the right merchant service providers
At the end of the day, the best merchant service provider is the one that makes it easy for you to get paid and doesn’t lock you into high fees or confusing contracts. Look for partners that offer transparent pricing, flexible terms, and the tools your business actually needs. Ready to simplify payment processing and keep more of what you earn? Check out Payment Depot, and see how much you could save.
