What Is Payment Processing? A Guide For Small Businesses
Payment processors help your small business accept credit card transactions, but how to do they work? Find out in this guide.
How does payment processing work? Payment processing is the series of digital communications between banks, processing networks, and POS systems that make it possible for your business to accept non-cash payments.
In short, if you want to accept payments via credit cards, virtual wallets, and more, you’ll need to implement payment processing. If you’re not sure where to start, we’ve got you covered.
This guide takes a deep dive into how payment processing works, what it takes to process payments, and how to choose a payment processor, so you can choose the best credit card payment processing company for your small business.
Let’s dive in.
Table of Contents
What Is Payment Processing?
Payment processing is a series of steps that facilitates communication between banks that includes authentication, transaction validation, funding, and fund settlement — it’s how businesses get paid when customers don’t use physical cash.
Payment processing allows businesses to accept payments via credit card, debit card, check, digital wallet, cryptocurrency, and more. While payment processing starts at your business’s point-of-sale system, funding and settlement (ie. when the money reaches your business’s bank account) can take up to three days.
How Does Payment Processing Work?
Payment processing is the approval and settlement of a transaction where a customer makes a non-cash payment, and your business receives the payment directly to its bank account. Here’s a step-by-step breakdown of how payment processing works.
- Payment is initiated via customer. Your customer pays via one of your business’s accepted payment methods.
- Payment information is validated for approval. Depending on the payment method, information like the card number, security code, expiry date, cardholder name, and more is received by a payment gateway and sent to a payment processor.
- The payment processor verifies the card’s security. This step in the payment process is just to ensure that the transaction taking place isn’t fraudulent.
- Your payment processor communicates authorized transactions. Depending on the payments used, payment processors communicate information about approved transactions to the source (eg. payment card networks like Visa or AMEX).
- Funds are debited from customer accounts. Once the transaction has been approved and validated, it moves into the settlement and funding phase, where money is debited from the customer’s account.
- Your business bank account is funded. The debited funds are transferred to your business bank account (ie. a merchant account).
What Is A Payment Processor?
A payment processor is a vendor that facilitates electronic payments by acting as the messenger between banks and merchants. The payment processor authenticates payment information and disburses funds to the merchant after a sale is complete.
When it comes to payment processing as a whole, payment processors are the companies that earn money by charging a fee for processing payments, regardless of the transaction’s outcome. In the US, some of the most popular payment processors include Helcim, Clover, Square, and Stripe.
What Is A Point-Of-Sale System?
A point of sale system, also known as a POS system, is a type of hardware or software that is used to facilitate payment processing. When accepting payments, your POS is where the transaction starts, whether it’s a customer walking up to the cash register to pay or checking out online.
What Is A Payment Gateway?
A payment gateway is a processing network that communicates over the internet to send and receive payment information between merchants, issuing banks, credit card associations, and other parties to a transaction. Payment gateways approve purchases, attempt to detect fraud, and help ensure that you receive your funds from a transaction.
The term payment gateway may also refer to a software-based service that allows merchants to process transactions solely over the internet, without physical access to the customer’s payment card. These cloud-based payment gateways are necessary for eCommerce, but are increasingly being used in brick-and-mortar businesses.
Payment Processor VS Payment Gateway
The terms payment processor and payment gateway sometimes get used interchangeably, and they can both be used to refer to the same thing — a payment processing network that confirms the validity of a transaction and transfers funds from that transaction to all the involved parties. Here, we use the term payment processor to refer to a business entity that processes your transactions.
Full-service payment processing requires tremendous resources and capital, so there are only a handful of companies that function as direct processors. Most merchant services providers, including payment service providers (PSPs) such as Square, contract with one of these large, direct processors to handle transaction processing.
What Is A Merchant Service Provider?
A merchant service provider is any entity that can coordinate non-cash payment processing for your business. Some merchant service providers combine payment processing and merchant account services, so merchant services providers can be further broken down into two categories: merchant account providers (MAPs) and payment service providers (PSPs).
Here’s the difference between merchant account providers and payment service providers:
How To Choose A Payment Processor For Your Business
When choosing a payment processor for your business, it’s essential to consider which payment methods you want to accept for your business. Depending on the payment method you choose to accept, you’ll have different costs and hardware requirements.
Here’s how the payment methods you choose to accept for your business will impact payment processor pricing and hardware needed.
What’s The Best Way To Process Payments?
With so many payment methods and payment processors to choose from, you’ll have to decide which ones are the best fit for your business. Whether you need a full-service merchant account or a payment service provider (PSP) will depend on the size and nature of your business.
Merchants operating seasonally or processing only a few thousand dollars per month can usually save money by signing up with a PSP. Larger businesses will require a full-service merchant account due to lower processing costs and increased account security.
For a brief overview of our highest-rated merchant services providers, check out our merchant account comparison chart.