From Swipe to Settlement: How Payment Processing Works

By Whitney Troxel

Payment processing is a crucial component of any business’s operations. It is the backbone of modern commerce and is what enables businesses to function. It’s somewhat ironic that such a critical aspect of daily business is considered an enigma by the business community at large.

The world of payment processing is complex, fragmented, and ever-changing. But that’s not an excuse to ignore it. We’ve seen small business owners and CEOs of major corporations alike make destructive business decisions simply because they didn’t have a basic understanding of payment processing.

Let us show you how increasing your knowledge of payment processing can turn it from a necessary business component into a strategic asset.

Payment processing essentials

Let’s go back to the basics and start with a definition. Payment processing is the process of accepting and processing payments from consumers. This can be done through a variety of methods, including online, over the phone, or in-person. In order to process payments a business must have:

  • A merchant account — an account with a bank or financial institution that allows a business to accept credit card payments
  • A payment gateway — a software application that securely transmits payment information between the customer and the payment processor
  • A payment processor — a third-party payment service that facilitates payment transactions between a business and its customers

In the United States, financial institutions are the only entities that can possess electronic funds (i.e. credit cards, debit cards, Google Pay, Apple Pay, etc). Therefore, bank-to-bank transfers are the only way to move these digital money sources. All other participants of this financial system — meaning payment gateways and payment processors — offer additional services or value.

Payment transaction lifecycle

A deep understanding of payment processing is essential for businesses that wish to maximize their profits. It allows them to accurately track sales revenue, reduce payment delays and errors, as well as create cost-effective structures for receiving payments. Being aware of the multiple possibilities offered through payment processing empowers executives with the confidence required to make today’s decisions which will benefit their companies in the future.

The lifecycle of a payment transaction is laid out for you in the following order.

Step 1: Initiation

A payment transaction is initiated when a customer submits payment information to your business, either in-person or online. There’s no shortage of payment options available, and they include the following:

  • Credit Card Payments — This is the most basic type of credit payment, where a customer uses their credit card to make a purchase.
  • Debit Card Payments — This type of payment is similar to a credit card payment, but the funds are deducted from the customer’s checking or savings account.
  • Electronic Check Payments — Electronic check payments, also known as e-checks, allow customers to make payments directly from their checking or savings account.
  • ACH Payments — Automated Clearing House (ACH) payments are electronic funds transfers that are processed through the Federal Reserve.
  • Mobile Wallet Payments — Mobile wallet payments allow customers to make payments using their mobile devices, such as Apple Pay or Google Pay.

Your payment gateway collects the payment information and sends it to your payment processor for the next step. A payment gateway can collect information in the following ways:

  • Online Payments — This is the most common form of payment processing and is used for e-commerce transactions.
  • Point-of-Sale (POS) Payments — POS payment processing is used for in-person transactions and is typically done using a card reader or terminal.
  • Over-the-Phone Payments — Phone payment processing allows customers to make payments over the phone using a credit card or electronic check.
  • Recurring Payments — Recurring payment processing allows customers to set up automatic payments, such as for a subscription service.

Step 2: Authorization

Your payment processor takes the submitted information and verifies it with the customer’s banking institution to ensure that everything is in order. This includes address verification service (AVS) and other fraud prevention processes. If the details match, and there are sufficient funds available, then the transaction will be authorized. Processors typically authorize or decline payments in a matter of seconds.

Step 3: Clearing

Once a payment has been authorized, your payment processor sends the transaction information to the customer’s bank or card issuer for processing. The bank or card issuer deducts the funds from the customer’s account and sends them to your payment processor.

Step 4: Settlement

Your payment processor then settles the transaction by transferring the funds from the customer’s bank or card issuer to your business’ merchant account. This process can take a few days to complete, depending on the payment method and the banks involved.

Your payment processor maintains a record of the transaction for both your business and your customer. You will receive proof of payment and your customer’s account will be updated once the transaction is complete.

Occasionally, customers will initiate a dispute or chargeback, but that’s a topic for another day.

Finding the right payment processor for you

At the end of the day, payment processing should be seen not as a mere cost of doing business, but as an opportunity for you to find a payment partner that can support your overall financial objectives. Different payment processors can offer different benefits and drawbacks, so you need to evaluate what will work best for your business. When evaluating payment processors, you should consider the following:

  • Business type — It is essential to select a payment processor that has experience working with businesses similar to yours. The needs of traditional companies are different from those of SaaS companies, which differ from the requirements of service providers such as doctors, lawyers, realtors, etc.
  • Business industry — Since payment needs and difficulties can differ significantly based on the industry, processors frequently specialize in different industries. If you partner with a processor that doesn’t understand your specific business needs, it could lead to lost revenue, held funds, and closed accounts.
  • Processing volume — How much income you generate is a key factor when choosing a processor. Processors that work with high processing volumes can offer advanced technology and services that may be too costly for businesses handling low processing amounts.
  • Ambition for growth — If you want your company to reach its full potential, you must select the right payment processor. It should offer solutions that will evolve with your business, not impede it! Too many entrepreneurs and executives restrict their growth by failing to plan ahead.

It’s always a good idea to research multiple options before choosing a processor. Take advantage of the sales process to make sure you find the right fit. Don’t be afraid to ask questions. You’re looking for a company that will become a partner, not just a provider. How they respond to your questions — especially the “dumb” ones — will give you good insight into what working with them will be like.

Turn knowledge to action

Now that you have a deeper understanding of payment processing, let’s talk about how this information will help you make smarter decisions.

  1. Ask more detailed questions. Too many business owners and executives lock themselves into detrimental contracts because they don’t know what to ask. Reading this article is not going to make you a payments expert, but it should help the payments industry be less terrifying. Engage payment processors and experts in conversation and keep learning!
  2. Develop a payment strategy. Don’t just plan for now, plan for the future. Always ask yourself “Will this payment solution still work for my business at our next stage of growth? The stage after that?” Identify growth blockers before they happen and plan how you’re going to resolve or avoid them.
  3. Talk to Nexio. Nexio provides a variety of payment solutions for a wide range of business types. Whether you’re a small business, a Direct Sales organization, or a SaaS company, we curate unique solutions that match your needs. Contact us for an obligation-free consultation and discover how Nexio helps you make payments a strategic asset.