Payment processing refers to the steps initiated by a business to accept credit card and other types of payments. The process is simple and automatic—taking only seconds. It starts from the swipe, dip, tap, or manual input of customer payment details at the merchant’s point of sale and involves the verification of those details, approval or denial of the transaction, and settlement.
Before we dive into how payment processing works, expand the section below if you need a quick background on what a payment processor is and the differences between a payment processor and a merchant account. Otherwise, skip these and proceed to the payment processing steps and how to set up payment processing for your business.
A payment processor is a service provider that handles all the tasks needed to ensure payment transfer. It includes one or more means of capturing payment information, such as credit cards, bank transfers (ACH), and digital wallets.
Payment Processor vs Merchant Account
A merchant account is an intermediary business bank account where a customer’s payment is sent before it goes to your own account. There are two types of merchant accounts:
- Dedicated merchant account: Unique to the business
- Aggregated merchant account: Shared account for multiple businesses under a single account held by a service provider
A merchant services provider provides a dedicated merchant account. This type is ideal for more established businesses.
On the other hand, a payment processor, also called a payment facilitator, is a service that allows merchants to accept different types of payments. Payment processors may provide businesses with aggregated merchant accounts so they can start accepting payments.
You may sometimes encounter the term credit card processor, which specifically refers to payment processors that allow merchants to accept credit and debit card transactions. Almost all payment processors offer this service, which is why the terms are often used interchangeably.
Many companies are both merchant services providers and payment processors, which is why these terms are often used interchangeably. Though they’re technically different behind the scenes, in practicality, they’re used the same way because most modern solutions do both.
Types of Payment Processing
Businesses can accept a wide range of payment types, depending on their payment processor. Here are some of the most common types:
- Credit or debit card payments: The most widely accepted payment method involves processing cardholder information through a point-of-sale (POS) system or online portal. The process is fast, secure, and convenient.
- ACH payments: ACH (Automated Clearing House) transactions transfer funds directly between bank accounts. These are commonly used for recurring payments like rent or utilities.
- Cryptocurrency payments: Payments made using digital currencies like Bitcoin or Ethereum, offering businesses an alternative method to cater to tech-savvy customers.
- Contactless payments: The use of NFC technology (near-field communication) allows customers to simply tap their cards or mobile devices to complete transactions without entering a PIN.
- Buy now, pay later (BNPL) payments: BNPL offers customers the ability to pay in installments through services like Klarna, Afterpay, or Affirm.
Entities in Payment Processing
To understand how payment processing works, it’s helpful to get to know the different entities involved and their roles:
Merchant: The small business selling products and/or services to the end customer; they’re the ones receiving money. | ISO/MSP: The Independent Sales Organization (also known as Member Service Provider) is a liaison between the card-issuing bank and the merchant. |
Customer: The individual or business who is making the purchase; they’re the ones providing money. | Issuing bank: The financial institution that provides the customer with their credit or debit card, or bank account. |
Merchant bank: The financial institution where the merchant keeps its funds. | Card association: Visa, MasterCard, American Express, and Discover are examples of card associations. |
Payment gateway: The technology that allows merchants to securely process payments from customers. | Point of sale (POS) system: You might use your POS system’s card reader or payment processing tools to accomplish steps along the way. |
Payment Processing in 3 Steps
So, how does payment processing work? There are three main steps involved: authentication of the account details, authorization of the payment, and settlement of the transaction.
The same flow applies whether the payment is made using a credit or debit card, a bank account, or a mobile wallet. We discuss the typical process for card payments below.
Step 1: Authentication
Though they happen nearly simultaneously and behind the scenes, payment authentication and authorization are two separate steps at the start of the transaction.
Payment authentication is the process of verifying the customer’s account. When the card payment is swiped at the terminal or entered online, the details, like the customer’s name and card number, are sent to the merchant acquiring bank. The merchant’s bank then forwards these details to the customer’s card issuing bank to verify that the details are accurate to prevent fraudulent transactions.
Step 2: Authorization
Credit card authorization is the transaction approval or denial process that happens nearly instantly at the point of sale. Once the account is authenticated, the customer’s card issuing bank approves or denies the transaction, which is then passed to the merchant acquiring bank and, finally, the merchant.
This is when you’ll see “Authorized” or “Declined” indicated at the point of sale. If the transaction is approved, the merchant will receive an authorization number.
At this point, the merchant’s POS or payment terminal can start the process of batching and sending out approved transactions for payment.
Step 3: Settlement
The settlement process is when the merchant actually gets paid. Many merchant services will batch and process transactions automatically, but depending on your processor, you may need to manually batch and settle transactions at each terminal at the end of the day. Either way, you’ll want to monitor all of your statements to make sure there are no outstanding authorized payments.
How to Set Up Payment Processing for Your Small Business
Setting up payment processing allows your business to accept payments securely. Choose a reliable processor, integrate it with your existing systems, and run test transactions to ensure everything works smoothly. Here’s a quick guide to help you get started.
Step 1: Choose a Payment Processor
Not all payment processors are equal. While many work with multiple industries, some are better suited for specific types of business and offer better deals and tools.
Here are some things to consider:
- Price is only one factor. Look at the tools they offer—POS systems, dedicated merchant accounts, and discounts for special situations (like nonprofits). Make sure they support all the payment methods you’d like to accept. Also, check whether they require a contract or charge month-to-month.
- Reputation is important. A good price won’t mean anything if the payment processor isn’t reliable or you are stuck with hidden fees. Do your research. We offer reviews, but also read user reviews and get recommendations from others in your field.
- Find top-notch security. It’s important to keep your business and customer data secure. Look for Payment Card Industry (PCI)-compliant payment technology and other safeguards such as chargeback protection and address verification systems (AVS).
Best Merchant Accounts & Payment Processors at a Glance
 |  |  |  | |
|---|---|---|---|---|
Best for | All-around, mobile | Online sales and integrations | Cheapest option for established businesses | High-risk merchants |
Monthly fees | $0 | $0 | $0 | $10-$45 |
In-person fees | 2.6% + 10 cents | 2.7% + 5 cents | From Interchange + 0.4% + 8 cents | 2%-4.3%, depending on risk |
Online transaction fees | 2.9% + 30 cents | 2.9% + 30 cents | From Interchange + 0.5% + 25 cents | 2.69%-4.25%, depending on risk |
Chargeback fees | Waived up to $250/month | $15 | $25 | |
POS | ✓ | Via API integration | ✓ | ✓ |
Card readers | ✓ | ✓ | ✓ | ✓ |
Mobile app | ✓ | Custom-developed | ✓ | ✓ |
Read our reviews |
Step 2: Integrate Your Payment Processor
When selecting your payment processing platform, it’s critical to ensure it meshes well with your existing tech stack or suite of business tools and tech. If you’re hard-set on a specific payment processor, but it won’t integrate with your website or POS, for example, be prepared to migrate to a new website platform or POS.
Step 3: Run a Test Transaction
Before launching your new payment portal to the public, do a test run with a dummy purchase and your own business credit card. This will help you flag any errors, saving your customers the frustration.
Part of your testing process should also include training or onboarding for any staff who needs to use the interface as part of their role.
Step 4: Launch Your New Payment Process
Once tested, you’re ready to launch your new payment processing tool. Push it live and let the payments roll in!
How Much Does Payment Processing Cost?
Payment processors typically charge anywhere from 2% to 5% per transaction for card payments, with 2% to 3% being the most common. Some, like Square, charge a flat rate. This means every transaction of a certain type is assessed the same fee, regardless of the credit card.
Others, like Helcim, charge interchange-plus. This takes the interchange fee charged by the credit card companies and adds an additional percentage or flat amount per transaction. It’s generally cheaper than a flat rate but varies from card to card and even type of credit card (Platinum vs Gold, for example).
The fees also depend on the payment method. Other payment types, such as ACH and cryptocurrency payments, may be more inexpensive, which usually have fees ranging from 0.5% to 1.5%.
Some payment processors charge a monthly fee in return for lower rates, especially when dealing with high-volume sales. If you have sales of greater than $20,000, this could save you money. (Some flat-rate processors, like Stripe, also have discounts for high-volume customers.)
Some payment processors charge different rates or have an add-on fee for international payments. Finally, some add fees for additional items, like a virtual terminal or fraud prevention.
Dealing With Chargebacks
Chargebacks happen when a customer questions a card transaction and asks their bank or credit card to reverse it. Sometimes, the customer has buyer’s remorse, dislikes the product, or does not recognize the purchase. Other times, it’s because someone stole their card or payment information and made an unauthorized purchase.
Regardless of the reason, chargebacks can get expensive for merchants. According to Chargebacks911, merchants will lose an average of $76 for every chargeback in 2024. Many payment processors charge chargeback fees. Others, however, waive these fees or even offer chargeback protection, which covers chargebacks due to fraud or friendly fraud.
Frequently Asked Questions (FAQs)
Click through the sections below to read answers to common questions on payment processing:
Online payment processing works almost exactly the same as in-person payment processing, just with a few additional layers. Online payment processing requires a payment gateway that acts as the intermediary between your website and payment processor that collects and tokenizes payment information for security. Most online payment processors have gateway functionality built-in, so in most cases, there is no need for a separate gateway.
While the authentication and authorization of card payment transactions are basically immediate, the settlement process takes longer. Most businesses see funds from payment processing in their bank accounts two to three business days after the transaction. However, some processors like Square will deposit funds immediately for a fee.
Other types of transactions, like ACH and check payments, can take longer to clear.
The point of sale (POS) is where a customer pays for goods, and the merchant rings up the transaction. POS systems are the software and hardware that manages transactions. The best POS systems also enable small businesses to manage inventory, customer relationship management, and track sales, among other functions.
When a payment is processing, the transaction request is sent from the merchant’s payment system to the payment processor, which communicates with the customer’s bank to authorize or decline the payment. Once authorized, the funds are transferred to the merchant, typically within 1 to 3 business days.
Bottom Line
Payment processing is vital for merchants that sell items online or in person. Payment processors transmit the customer payment information to the credit card company or payment association (like Google Wallet) for authentication and authorization, and once approved, enact the transfer of funds into your merchant account for later transfer to your business account. It’s a quick and often invisible process.
