Understanding the Payment Processing System: A Small Business Owner’s Guide
In 2023, it is no longer optional for small businesses to accept payments from credit cards and it’s becoming increasingly less optional to accept mobile payments. 80% of people prefer using card or digital wallet payment over cash or check.
However, payment processing services and accepting card payments are fairly complex things for a small business owner to approach. It’s nonetheless crucial to understand the terminology, technology, and processes so that you don’t end up in a contract that doesn’t work for your business.
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 processing 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.
- 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.
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.
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.
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.
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.
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.
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.
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 onto a compatible smartphone for use as an in-store digital wallet.
Gift cards help to build customer loyalty and encourage repeat purchases. Merchant accounts often include a gift card program.
Other payment processing 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 the 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
Payment Depot has a 4.5-star rating on Trustpilot from customers. Positive reviews frequently mention the quick and helpful customer service.
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
Square’s Trustpilot rating is 4.1 stars. Positive reviews particularly highlight the system’s ease of use.
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
Stripe’s Trustpilot rating is 3.4 stars. While the reviews do trend negative, positive reviews say that customers particularly like Stripe’s easy-to-use interface.
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
PayPal’s Trustpilot rating is a low 1.3 stars. The reviews are overwhelmingly negative, speaking to a variety of issues like surprise fees and lack of support.
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
Stax has a 4-star rating on Trustpilot. Positive reviews rave about their customer support, saying it’s personal and quick at resolving issues.
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.