Understanding the Payment Processing System: A Small Business Owner’s Guide

Understanding the Payment Processing System: A Small Business Owner’s Guide

While the worldwide economy continues to recover from COVID-19 disruptions, the global payments industry is growing at breakneck speed. As Business Wire notes, global payments should expand at an 11% compound annual growth rate (or CAGR) from 2020 to 2021.

From a numbers perspective, this means an increase from $466.29 billion to $517.68 billion. By 2025, global payments are likely to total $735.39 billion, demonstrating a 9.2% CAGR.

Although cash and checks have seen decreased use, digital payments are becoming increasingly popular. Merchants are expected to offer a number of different payment methods for customers. This easy-to-follow primer outlines how a card-based payment processing system operates.

How a payment processing system works 

The term “payment processing” refers to the sequence of authenticating and approving a customer transaction. Afterward, the proceeds are transferred to the merchant, minus the transaction fees.

The credit card transaction sequence

Each credit card transaction follows a multiple-step sequence. This process ensures that the transaction is complete and all parties receive the funds due from the sale.

  1. The cardholder provides the merchant with credit card information at checkout. This occurs through a card terminal, a mobile card reader, or an online payment page.

2. The payment information travels through a payment gateway to the payment processing company.

3. The payment processor sends the transaction to the card network (Visa, Mastercard, etc.) for approval.  

4. The card network approves or declines the transaction based on the customer’s available credit.

5. The merchant completes the approved transaction, and the customer receives their merchandise. If the transaction is declined, the customer will be asked to provide an alternative payment method.

6. The payment processor remits the interchange fee to the issuing bank and card network. The processor tells the customer’s bank (the card-issuing bank) to forward funds to the merchant’s bank (the acquiring bank).

7. The net proceeds are deposited into the merchant’s bank account.  

Common payment processing industry terms

A typical transaction sequence will become clearer once you understand the meaning of certain payment processing terms. Here are six common terms pertaining to a credit card transaction that you may often come across.

Payment gateway

A payment gateway is an internet-based communications conduit. During a credit card transaction, issuing banks, acquiring banks, credit card associations, and other entities send information through a payment gateway.  

Payment processor

A payment processor (or payment processing company) executes credit card payments and other digital transactions. These credit card processing companies are merchants’ links to card-issuing banks, acquiring banks, and credit card networks. The processor ensures that merchants receive the funds from completed transactions.

Point-of-sale 

A merchant’s point-of-sale (or POS) system is the business’ payment operations nerve center. Together, a POS system’s hardware and software enable merchants to begin accepting payments.

POS systems commonly accept credit cards and debit cards. Contactless payments, mobile payments, and online payments are other payment methods.  

Issuing bank

The issuing bank (or card-issuing bank) is the financial institution that provides the customer with a credit card. Essentially, the issuing bank extends a revolving loan to each cardholder. The acquiring bank (or acquirer) facilitates credit card processing services for the merchant.

Merchant services provider

A merchant services provider is a payment processing company that oversees payment transactions. The merchant services provider also ensures that merchants receive their net proceeds.

Some merchant services providers assign each business a separate account. Other providers pay each merchant’s net proceeds from one combined account.  

Merchant account

The merchant services provider’s merchant account serves as the temporary repository for credit card transaction proceeds. The net funds are transferred to the merchant’s business bank account. 

Common payment processing methods

In today’s digital marketplace, merchants typically provide customers with multiple payment options. This practice accommodates customers with varied payment preferences.

Credit card processing

The term “credit card processing” describes a purchase transaction using a Visa, Mastercard, American Express, Discover, or other credit cards. Transactions frequently involve EMV (or chip) cards containing enhanced security technology. Each real-time transaction follows the same sequence.

Debit card processing

Consumers often use debit cards for smaller purchases such as coffee, snacks, and gasoline. Because these funds come from the customer’s bank account, the card network incurs less risk. Therefore, business owners incur a lower interchange rate.

Contactless payments

A contactless payment integrates near-field communications (or NFC) technology. An NFC payment involves a short-range radio in the customer’s payment device and the card terminal. When the customer waves the device near the terminal, the payment is processed from their card.

ACH payments

Within the United States, Automated Clearing House (or ACH) digital payments are drawn from the customer’s checking account. Many e-commerce transactions, including Shopify payouts, incorporate an ACH payment function.

Device-based digital wallets 

Device-based digital wallets, such as Apple Pay, enable payments with an Apple Watch or iPhone. Similarly, a PayPal app can be loaded to a compatible smartphone for use as an in-store digital wallet.

Gift cards 

Gift cards help to build customer loyalty and encourage repeat purchases. Merchant accounts often include a gift card program.

Other payment methods 

Most small business owners do not take Bitcoin or other digital currencies. To accept these payments, your merchant services provider will likely work with a third-party processor.

Payment processor selection criteria

The following six factors will help you narrow your search for a payment processor. Select the company that represents the best overall fit.

1. Nature of the business 

Decide which payment methods suit your business model. For example, customers at a coffee shop want fast transactions. Therefore, credit card payments, mobile payments, and contactless payments are good payment options.  

In contrast, customers at an e-commerce store need a reliable online payment mechanism. Credit and debit cards are optimal solutions.

2. Pricing structure transparency  

Credit card processing companies are notoriously vague about pricing information. In most cases, prospective customers need to contact a sales representative for pricing details.

Contracts often contain hidden fees and hefty cancellation penalties. Read the fine print thoroughly before signing it.

3. Transaction fees

Besides monthly service fees, many payment processors charge often-murky transaction fees. In contrast, desirable interchange-plus pricing is a transparent pricing structure. Besides the card networks’ interchange fee, the credit card processor sets a markup fee.

4. Software integrations

Many payment processors offer software integrations for use with customers’ business applications. Industry-specific applications are also available. An application programming interface (or API) enables two applications to work together.

5. System and data security

A payment processor’s promotional material should state that the company meets PCI DSS (or Payment Card Industry Data Security Standards) criteria. Therefore, the processing company meets industry standards for protecting customers’ card data. Choose the PCI compliance level that meets your company’s security needs.

6. Customer support 

Choose a payment processor that offers 24/7 phone-based customer and tech support. The company should also provide email and chat services. Ensure that knowledgeable support team members are available by phone when you need them.  

Best payment processors for small businesses

Now that you know the factors to consider when choosing a payment processor, let’s review five of the best payment processing services worth consideration for small business owners.

1. Payment Depot

Known for its superior customer support and PCI compliance, Payment Depot serves companies in numerous industries. Payment Depot’s customers can accept major credit and debit cards plus mobile-based payments. Key features and benefits include:

  • Membership-based pricing for cost savings
  • No markups, add-on fees, or cancellation fees
  • Free virtual terminal and payment gateway

2. Square

Square’s easy setup enables merchants to quickly begin accepting in-store and online payments. The system accepts every major credit card and many internationally sourced cards. 

Square’s flat-rate pricing means no chargeback fees, monthly fees, PCI compliance fees, or early termination fees. On the downside, Square only offers phone support during regular business hours. Key features and benefits include:

  • Multiple hardware options for different merchant needs
  • Industry-leading technology and security features
  • Loyalty programs and payroll services

3. Stripe

Stripe is known for its e-commerce-friendly service features. The company accepts many major cards and digital payments. On the downside, Stripe’s 24/7 customer support only includes email and chat services. Business owners can request a phone call requiring a short wait. Key features and benefits include:

  • Numerous business software integrations
  • Flat-rate pricing with no monthly fees or minimum volumes
  • Custom pricing solutions and large-volume discounts

4. PayPal

Businesses with lower monthly sales may choose PayPal. Setup is fast and easy, and merchants can accept all major credit cards and debit cards. On the downside, PayPal can hold merchant funds upon suspicion of fraudulent activity. Phone support is limited to business hours. Key features and benefits include:

  • No start-up expenses, monthly fees, or contracts
  • Fast payments with immediate funds for a small fee
  • Integration with certain POS systems and applications

5. Stax

Stax by Fattmerchant is designed for large-volume businesses. Merchants can accept all major credit cards and debit cards. On the downside, new customers must wait approximately 10 days for account approval and equipment shipment. Merchants pay high monthly subscription rates and transaction fees. Key features and benefits include:

  • Merchant access to virtual POS terminal 
  • Membership-based pricing and 0% interchange rate markup
  • 24/7 phone support plus email and live chat services

Choosing the best payment processor 

Budget-conscious small and medium businesses often choose Payment Depot. This membership-based payment processor offers wholesale pricing, fast funds deposit, and no cancellation fees. The company offers around-the-clock customer support that repeatedly gets rave reviews. Contact our award-winning support team today to learn how we can help you save more than $400 per month in credit card processing fees. 

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