The provider of the payment processing service checks if the buyer has enough money in their account to complete the transaction. The service provider will transfer the funds to the merchant's account if the account has sufficient funds. Payment gateways are responsible for sending the buyer's sensitive payment information to the payment processor.
Payment gateways are especially crucial for online businesses because money cannot be moved from bank to bank due to security concerns. Additionally, payment processors must comply with the Payment Card Industry Data Security Standard (PCI-DSS), ensuring the client's payment information is stored, transmitted, and processed safely by all the entities involved.
The terms ‘payment processors’ and ‘payment gateways’ are often used interchangeably, but there's a difference. Payment processors allow the transaction to take place securely, while payment gateways notify the merchant whether the transaction has gone through. Some payment processing companies combine different services, such as offering a payment gateway and a merchant account to ensure that you only work with a single entity.
The steps involved in payment processing have been reduced significantly in a bid to enhance the customer transaction experience. With new technology, the payment processing industry is pushing for easy-to-use solutions that can handle different payments at a cheaper cost.
While different providers offer varying services, here are some of the critical steps involved in payment processing from the client end to the merchant:
Customers now have access to multiple payment options when making a purchase. For clients, the process is straightforward and takes only a few seconds. On the business end, payment processing is a complex process involving different players and steps.
As a business, your payment processing has to be seamless to enhance your client's experience, so picking the right option for your business is crucial. In this article, we explain what payment processing is, how it works, and seven of the best payment processing options for small businesses.
Payment processing is the method businesses use to complete transactions involving debit and credit cards. Any digital transaction must be processed, whether you're running an online or physical store. Behind the scenes of each transaction, there are payment gateways and processing companies that act as a link between financial institutions and the individuals involved in the transaction.
The process usually involves the following entities:
Despite the complex mechanics that go into processing payments, all these steps must happen in a few seconds and be seamless to ensure the sale is completed successfully.
Payment processors can be divided into payment service providers (PSPs) and merchant account providers (MAPs), as described below:
Merchant accounts are essential to every online business since they allow buyers to deposit funds directly from their debit or credit cards to your business bank account. Once a client makes a card payment, and it's processed and approved, the funds are transferred from the card's bank to the merchant account.
Within 24 hours to three days, the funds will be funneled to your business bank account through an Automated Clearing House (ACH) transfer. There's a vast difference between a merchant account and your regular business account. Standard business accounts are mainly used for covering operational costs, while the merchant account is strictly for processing debit or credit card payments.
Merchant account providers act as a holding area for pending cardholder transactions and must strictly follow all the regulations stipulated by the debit or credit card associations. While merchant account providers are very stable, they're a bit expensive, making them more popular among medium and large businesses.
Most start-ups and small businesses prefer the simple payment service provider over merchant account providers. It's an excellent alternative for companies with a low card turnover, allowing them to accept card payments without necessarily setting up a merchant account.
Payment service providers avoid using a dedicated merchant account for each business by sharing a single account among different merchants, reducing the fees associated with individual merchant accounts. On the downside, without a unique merchant account ID, security concerns and account stability constitute a significant concern for this model.
The account could be terminated or frozen unexpectedly, but the overall costs of payment service providers are significantly cheaper for newly established or small businesses. Apart from the standard transaction fees, merchant accounts require additional fees for maintenance, which vary depending on the processor.
As a small business, your payment processor is not only facilitating transactions; they're part of factors that directly impact customer experience. As such, it's essential to have a service provider that allows you to customize payment solutions to meet your business objectives.
Here are seven of the best options for small businesses:
Since 1982 when the first e-commerce company launched, online markets have grown exponentially in just a few decades. According to the Census Bureau, online marketplaces have grown from $5 billion in sales in 1998 to an $815.4 billion industry by 2020. In the modern e-commerce industry, online payment processing is a top priority for every business.
Online payment processing became popular during the 2020 pandemic, encouraging greater use of contactless payment options. In addition, with online payments, businesses could offer better financing options, set up recurring payments, process payments made with foreign currencies, and accept or decline transactions based on pre-set parameters.
More merchants are now open and adapting to online payment options thanks to P2P websites and apps such as Square Cash and Venmo, which have grown in popularity and are estimated to reach $797.43 billion in terms of volume and 101.8 million users by 2024.
Credit cards were introduced almost a century ago, but their use has become more popular over the past few decades. According to the Federal Reserve System, more than 83% of American adults had a credit card in 2020. This has created a headache for most small businesses since implementing credit card payment is no longer a choice, and they have to secure a merchant, which comes with extra costs.
Fortunately, the high prevalence of credit cards in the United States means that the additional sales cover most, if not all, of the small business's merchant account maintenance costs. Banks issue most credit cards, but other financial institutions, such as Mastercard, Visa, American Express, and Discover, can also offer the service.
Each credit card provider charges different fees whenever a transaction is made using one of their cards. These fees are known as interchange and vary widely depending on the card's type. In exchange for the card provider's processing service, it's charged to both the merchant and the buyer, in addition to markup.
By offering small businesses simplified payment processing rates, credit card providers have made substantial profit margins through tiered pricing and flat-rate financing. Due to this, the interchange-plus pricing model is highly recommended because it adds a fixed markup to each transaction. The interchange fee varies from sale to sale, but the markup paid to the credit card payment processor remains the same for each transaction.
While the transaction process is rather complex, the advent of credit card processing networks and interconnected banking have sped the process to just a few steps. To simplify the process: data collected from the customer's card are submitted to the service provider, who contacts the client's bank to confirm if the buyer has enough credit to complete the transaction.
There are several security checks as well, and if everything checks out, the transaction will be approved. The payment processor company will process the transaction by paying interchange fees to the client's bank and credit card associations. After this step, the funds will be wired to the seller's merchant account.
The last step can take much longer since most merchants usually compile their transactions, submitting them as one document at the end of each day. This means it can take several days before the funds can reflect in your business account.
Debit cards are another popular payment option among consumers, especially for small daily expenses, such as fuel and groceries. According to the Federal Reserve Bank of Atlanta, U.S. consumers made 60 payments every month on average, with debit cards accounting for 23 of those payments, followed by credit cards at 18 payments and cash with 14 payments.
Debit card payment processing is much easier because the client's bank or card provider doesn't have to consider if they should give the client credit to cover the costs of the transaction. From the merchant's perspective, debit and credit card payment processing might look the same, but the difference is in the back-end.
When the customer taps, swipes, or waves their debit card, the information goes through the Point of Sale (POS) to the payment processor service provider before finally being sent to the issuing bank. The card network is removed from the process, meaning the merchant and the client's bank are in direct contact.
The transaction will be approved if the client has enough money in their account. Since credit isn't required, the overall risks associated with debit card payments are much lower, resulting in lower interchange rates than credit cards. While the process is still complicated, the lack of a card network lowers processing fees.
Experts often advise against tiered or flat-rate pricing plans because most payment processors who offer programs under the model charge the same interchange rates for using credit cards, even if you're using debit. However, these processors have a no-account-fee policy incentive, making such pricing plans considerable among small or seasonal businesses.
If you want your business to start accepting debit card payments while paying the lowest rates possible, here are all debit card processing options available for you to implement:
You must add a PIN pad to your countertop terminal setup due to its extra layer of fraud protection. The PIN pad effectively authenticates the client's debit card by allowing them to enter their PIN into the setup directly.
It's also more secure than collecting signatures from clients and offers the lowest processing rates in the payment processing industry. Without a PIN pad, the debit card payments will be processed as credit card payments, and high processing rates will apply.
Credit and debit card payments might be reigning as the most used non-cash payment methods, but there are other options available to the client that require the services of a payment processor to ensure the business gets its funds. Automated Clearing House (ACH) payments are gaining traction in the U.S. for generating all-digital payments from the issuing bank, especially in the e-commerce industry.
ACH is an electronic funds transfer system that facilitates payment in the U.S. and is run by the National Automated Cleaning House Association (NACHA). As a self-regulating body, NACHA provides the ACH Network with its administration, development, management, and rules to more than 10,000 institutions.
The ACH network is an economic hub that helps individuals and businesses to move funds from one bank account to another. Automated clearing house transactions are made of direct deposits (transfers made to an account) and direct payments (involving money going out of an account), including government transactions, consumer transactions, and business-to-business (B2B) transactions.
Originators (organizations, individuals, or governments) initiate the process by making a direct deposit or payment transaction (credit or debit) using the ACH network. The issuing bank, also known as the originating depository financial institution (ODFI), accepts the ACH transactions and compiles them together with other ACH transactions to be sent at regular intervals throughout the day.
An ACH payment processor (either the Federal Reserve or a Clearing House) receives the transaction batch from the ODFI, with the originator's transaction included. The ACH payment processor then sorts the transaction batch and makes them available to the bank or financial institution of the receiving depository financial institution (RDFI), the intended recipient.
The intended receiver's bank account is then wired the funds, thus reconciling both accounts and ending the process.
Since ACH payment implements bank-to-bank infrastructure, it provides significant benefits for businesses that require to take payments on an ongoing basis. Some of these benefits include:
While automated clearing house transfers are highly convenient, they aren't necessarily perfect. Many financial institutions and banks impose a limit on the number of funds you can send through an ACH transfer. In addition, transferring too frequently from your savings account might trigger a penalty, or the bank could convert your savings account into a checking account if frequent transfers become routine.
To determine whether ACH payments are the best solution for your business, here are some questions you need to answer:
Since smartphones and tablets were introduced, they have become powerful enough to handle numerous crucial consumer and business tasks. Smartphones have made life easy for small and medium-sized companies in almost every industry since they can see the value of mobile payment processing much more quickly.
Mobile payment processing is an umbrella term that covers several payment methods, including:
Mobile payment processing will differ depending on your provider, but with clients looking for more convenient ways to make payments, adding mobile payments to your options is an excellent idea since it's affordable, secure, and flexible.
Mobile payment processing involves the same process as a mobile POS system as long as you have the right technology stack (hardware, mobile payment app, and software).
Here are a few things that you need for mobile payment processing:
Two types of contactless payment methods— Near Field Communication (NFC) reader and QR code payment apps—are mainly used for mobile payment processing to facilitate wireless client payment data transfer to a mobile reader.
Most mobile payment processors are built on the Near Field Communication technology that allows two separate devices to exchange information as long as they're close to one another. The consumer accesses the technology through built-in mobile wallets, an app that stores credit and debit card information and allows the user to make digital purchases. They're pretty secure, with most mobile wallets requiring biometric authorization before someone can access the account.
The other available option is through QR code apps. These apps let you finalize sales anywhere by allowing clients to scan their payments without having to retrieve their debit or credit card or mobile wallet app. With QR payments, you generate digital QR codes on your mobile device and have the clients scan them through their phones. A payment screen appears within seconds, allowing the customer to complete the transaction.
There are two types of payment options when it comes to mobile payments: Magstripe and EMV. Magstripe is the common name for credit cards that are swiped to authenticate a payment. With these cards, the client's payment data is saved in the Magstripe, a magnetic stripe found on your credit card. The magnetic strip is unencrypted and static, posing a considerable security risk to the client's payment information.
EMV is the standard term for payments completed through credit card chips. EMV is more secure than Magstripe because the chip data dynamically encrypts customer payment information. However, due to the complexity of data from EMV transactions, the process could be much slower.
PCI compliance is responsible for operational standards that your business must meet to secure and protect sensitive credit card information offered by clients when making a purchase. These regulations are overseen by the PCI Security Standards Council and often cover issues such as safety protocols, among others.
An eCheck, also known as direct debit, electronic, internet, and online check, is the digital version of the old paper check. It's supported by the automated clearing house infrastructure that allows direct debit from the client's bank account into the business's account with the help of payment processors.
The bottom line is always on the top of many small business owners' minds, and one of the ways to ensure the money keeps flowing is by accepting payments that are convenient for both the business and the client. While they aren't that common, eCheck payment can be part of your payment options.
Due to ACH, eCheck payment processing differs from standard debit and credit payment processing. The use of ACH makes the process much cheaper; there are no credit card interchange fees, and the cost per transaction can be as low as ten cents. This can be a huge plus if your business accepts recurring or more significant payments.
For eCheck payments to go through, the merchant must have the client's information, including their checking account and bank routing numbers. This information can be acquired in person, on the phone, or online via a form. With this information, the merchant's bank will then communicate directly to the client's bank, and once everything is verified, the funds will be transferred through ACH.
While there are global payment processing companies, implementing local payment methods that are popular in specific regions is always ideal. For example, if you're looking to attract or maintain clients from China, Alipay is one of the popular local payment methods in use. On top of client convenience, implementing local payment methods can boost client loyalty and market penetration.
Local payments allow you to think locally while growing globally. To that end, you should understand which local payment your target market prefers the most to ensure the growth of sales while reducing cart abandonment. Local payment can include local credit or debit card providers, digital wallets, bank transfers, open invoices, and cash vouchers.
If your business falls under any of the following, you should consider implementing local payment solutions to your business:
Given the wide range of local payment methods, their popularity also varies from one region to another. In most cases, there's no one-size-fits-all approach that businesses can implement; instead, the focus is on providing customers with their preferred payment methods based on their financial habits. Here are different local payment options based on regions and countries:
It's the largest e-commerce market globally, with two of the five countries with high retail sales coming from the region. However, in terms of payment, everything is highly localized. For example, despite India being among the fastest-growing e-commerce markets, most people prefer to use cash. While in Japan, about 99% of Japanese citizens speak Japanese as their first language, so you have to optimize your content according to their expectations.
European countries have diverse cultures, which are evident in their preferred range of payments. In Western Europe, credit cards are more popular, while in Eastern Europe, cash and credit cards are more prevalent. In Russia, only a tiny population uses credit cards, and most prefer cash. Sweden is the complete opposite, with only 13% of the population using money to make purchases. Here, they prefer using debit cards and Klarna, a buy-now-pay-later financing provider.
In this region, e-commerce only accounts for 4.2% of all retail sales, with Brazil accounting for nearly a third of the entire sales. In Latin America, most people prefer debit and credit cards, many of which can only be used domestically. Vouchers and cash are also quite popular among the majority of the people who don't have a bank account.
As trust in the security of mobile payments continues to grow, the number of eWallet users in Mexico, Brazil, and Argentina is expected to grow
As a small business, offering your clients different payment options could be the difference between you and your competitors. Unfortunately, keeping track of the different payment processes can be complex and time-consuming. Leveraging an expert service provider ensures all the hard work is done so you can focus on growing your business.
This is where Smith.ai comes in. We can help you fill the gaps in your business so you can direct your attention to the bigger picture. Leave these and other tasks to our highly trained virtual recpetionists:
At Smith.ai, we'll help you choose the best payment processor to match your firm's financial needs and growth goals. Schedule a free consultation today to learn more about how we can help.