Businesses of all sizes must understand the complex fundamentals of payment processing to stay competitive and offer their customers simple, secure, and convenient ways to pay. This is especially true with global ecommerce transaction volume expected to reach $25 trillion by 2027.

For businesses that accept customer payments, payment processing plays a significant role in managing cash flow, enhancing customer satisfaction, and mitigating fraud risks. As the payment industry evolves alongside rapid technological advancements and changing customer behavior, businesses must stay informed about industry trends, regulations, and security standards to ensure they can adapt.

Below, we’ll cover different aspects of payment processing, including the key components, how payment processing works, best practices for businesses, and the importance of choosing the right provider to help you build and maintain an effective payment processing system. Understanding these concepts means businesses can make informed decisions about their payment processing strategies and solutions—and provide customers with a payment experience that drives growth.

What’s in this article?

• What is payment processing?
  
• Why payment processing is important for businesses
  
• Key components of payment processing
  
• How does payment processing work?
  
• Payment processing costs and fees
  
• How to choose a payment processor
  
• How Stripe Payments can help
  

What is payment processing?

Payment processing is the sequence of actions that securely transfer funds between a payer and a payee. Typically, it involves the authorization, verification, and settlement of transactions through electronic payment systems.

Payment processing systems cater to various types of transactions, including credit and debit cards, electronic funds transfers (EFTs), automated clearing house (ACH) transfers, mobile payments, digital wallets, and cryptocurrencies. A diverse set of stakeholders—including banks, financial institutions, payment processors, technology providers, businesses, and regulatory bodies—develop and manage these systems.

Why payment processing is important for businesses

A wide range of technologies, services, and financial instruments (any physical or digital instrument used to make cashless transactions, such as a credit or debit card) work together to ensure the fast and secure transfer of funds between parties.

Payment processing systems do the following for businesses:

• Facilitate trade and economic growth
  The payment processing solutions that a business adopts dictate how well that business is able to interact with customers and the broader world of commerce.

• Help businesses manage their operations
  Businesses of all sizes depend on efficient and reliable payment processing to help manage cash flow, customer satisfaction, and overall business operations.

• Meet customer preferences and needs
  By offering a variety of payment options, businesses can cater to the diverse preferences of their customers, increasing convenience and fostering trust.

• Reduce fraud and maintain compliance
  A well-functioning payment processing system also helps reduce the risk of fraud, ensure data security, and maintain compliance with relevant regulations and industry standards.

The payment processing landscape has evolved significantly in recent years, driven by advancements in technology, changing customer behavior, and the rise of new market players.

These changes have resulted in the emergence of innovative payment solutions, greater accessibility to financial services, and increased competition in the industry. As a result, businesses and customers can now benefit from payment processing options that are faster, more secure, and more convenient.

Key components of payment processing

Payment processing involves multiple components that work together to enable secure, efficient transactions between the customer and the business. These components include:

• The customer: The individual or entity that initiates the payment for goods or services
  
• The merchant: The business or service provider that accepts the payment from the customer
  
• The payment method: The method the customer uses to make the payment, such as credit cards, debit cards, electronic wallets, or cryptocurrencies
  
• The point-of-sale (POS) system: The physical or digital platform where the transaction takes place, such as a retail-store terminal, ecommerce website, or mobile app
  
• The payment gateway: A service that securely captures and transmits payment information from the POS system to the payment processor or acquiring bank, ensuring the encryption and security of sensitive data during the transaction process
  
• The payment processor: A third-party company that handles the technical aspects of the transaction, including validating payment information, obtaining authorization, and managing communication between the acquiring and issuing banks
  
• The acquiring bank, or acquirer: The financial institution that holds the merchant's account, receives the payment on its behalf, processes the transaction, and settles the funds in the merchant’s account
  
• The card network: Organizations (e.g., Visa, Mastercard, and American Express) that establish the rules, standards, and infrastructure for processing transactions, using their branded payment instruments
  
• The issuing bank, or issuer: The financial institution that has issued the payment instrument to the customer and is responsible for authorizing or declining the transaction, based on the customer’s account status, available funds, and other factors
  
• Payment security: Technologies and standards—such as the Payment Card Industry Data Security Standard (PCI DSS), tokenization, or encryption—that ensure the safety and integrity of payment information and protect against fraud and data breaches
  
• Settlement and reconciliation: The process of transferring funds between the issuing bank and the acquiring bank, followed by updating the merchant’s account and generating transaction records for the customer and the merchant
  

Each component plays an important role in the process, ensuring that transactions are completed securely, efficiently, and in compliance with applicable regulations and industry standards.

How does payment processing work?

The process involves several steps and multiple parties. Here’s how payment processing works:

1. Customer initiates payment and submits card details
   The customer initiates the payment by providing their payment information (e.g., a credit card, debit card, or another payment method) at the point of sale in a physical store, or through an online platform like an ecommerce website or mobile app.

2. The payment gateway encrypts and transits the data
   Once the customer submits their payment information, it’s securely transmitted to the payment gateway, which acts as a secure bridge between the customer, the business, and the payment processor.

3. The payment processor and card network request authorization from the issuing bank
   The payment processor receives the transaction data from the payment gateway and validates the information. It forwards the transaction details to the acquiring bank, which sends the information to the card network for validation and authorization.

4. The issuing bank approves or declines the transaction and sends a response
   The issuing bank sends back the authorization response through the card network to the acquiring bank, which then forwards the response to the payment processor. The payment processor then sends the response to the payment gateway, which communicates the result to the business’s POS system or online platform.

5. Approved funds are captured and settled into the merchant's account
   If the transaction is approved, the business completes the sale by providing the customer with the goods or services. At the end of each day, the business sends a batch of approved transactions to the payment processor or the acquiring bank for settlement. The acquiring bank requests the funds from the issuing bank through the card network.

Payment processing costs and fees

Understanding the cost of payment processing requires looking at the total percentage and flat fee a business pays on every transaction. This total is typically composed of three main components:

• Interchange fees
  Interchange fees are set by the card networks, like Visa and Mastercard, but are paid to the issuing bank. These fees cover the bank’s risk and the cost of maintaining the account, and can vary based on card type, business industry, and the level of risk involved in a transaction.

• Assessment fees
  Assessment fees are paid directly to the card networks for the use of their network and brand. These are typically much smaller than interchange fees and are also nonnegotiable for the merchant.

• Processor fees
  Unlike interchange and assessment fees, this is the only part of the cost that is potentially negotiable. It covers the processor's overhead, technology, and customer support.

Processors generally bundle these three costs into one of the following pricing structures:

• Flat-rate pricing
  The merchant pays a fixed percentage for every transaction (e.g., 2.9% + $0.30), regardless of the actual interchange cost. This is simple and predictable but can be more expensive for high-volume businesses.

• Interchange-plus pricing
  The processor charges the actual interchange and assessment costs, plus a transparent, separate markup (e.g., Interchange + 0.20% + $0.10). This is often the most transparent and cost-effective model for growing businesses.

• Tiered pricing
  Transactions are categorized as "qualified," "midqualified," or "nonqualified" based on risk. This model is often the least transparent, as it can be difficult to predict which tier a specific card will fall into.

How to choose a payment processor

Choosing the best payment processor for your business will depend on your needs, industry, size, and other factors. Here’s what to consider when choosing a payment processor:

1. Define your sales channels
   Determine where you will be accepting payments. If you are strictly ecommerce, you need a processor with a robust online gateway. If you have a physical storefront, you’ll need one that offers integrated POS hardware. For omnichannel businesses, look for a unified commerce provider that can sync data between online and offline sales.

2. Evaluate integration, ease of use, and support
   Check if the processor integrates directly with the tools you already use, such as your accounting software or ecommerce platform. A processor that requires custom coding can be expensive to maintain, whereas a “plug-and-play” solution saves time. Look for a processor that offers 24/7 human support via phone or live chat. Relying solely on an email ticketing system can lead to costly downtime if your ability to take payments is interrupted.

3. Compare pricing models against your volume
   Choose a pricing structure that aligns with your transaction volume. Small businesses with low monthly sales often benefit from the predictability of flat-rate pricing. Higher-volume businesses can usually save significant money by choosing interchange-plus pricing, which offers more transparency and lower margins.

4. Prioritize security and compliance
   Ensure the processor is PCI DSS compliant and offers advanced fraud protection tools, such as tokenization and end-to-end encryption. This reduces your liability and protects your customers' sensitive data without requiring you to manage the security infrastructure yourself.

5. Check payout speeds
   Cash flow is the lifeblood of any business. Review the processor’s settlement schedule. Some providers offer next-day—or even instant payouts—while others may hold funds for 2 to 3 business days. Be sure to check if there are additional fees associated with faster access to your money. Payment processing best practices for businesses

Implementing payment processing best practices can enhance the customer experience, minimize the risk of fraud, and maintain compliance with industry regulations and standards. Additionally, upholding these best practices is a good way to cultivate a well-structured set of internal processes for payments, which will use resources efficiently and minimize errors.

Here are some key payment processing best practices for businesses:

• Build a secure payment environment
  Implement robust security measures, such as encryption, tokenization, and secure sockets layer (SSL) certificates, to protect sensitive payment data during transmission and storage. Comply with PCI DSS and other relevant security standards to ensure a secure payment environment.

• Offer diverse payment options
  Cater to the diverse preferences of your customers and enhance their shopping experience by offering multiple payment options, such as credit and debit cards, digital wallets, and alternative payment methods.

• Use a reputable payment processor
  Choose a reliable and reputable payment processor that offers comprehensive payment processing solutions, advanced fraud-prevention tools, competitive fees, and excellent customer support.

• Regularly update software and hardware
  Ensure that your payment processing software, hardware, and integrations are up-to-date with the latest security patches and technology advancements. This reduces vulnerabilities and maintains the efficiency and security of your payment processing system.

• Train employees
  Educate your employees about payment processing best practices, security protocols, and fraud-prevention measures. Ensure that they are aware of your company’s payment processing policies and procedures and can recognize and respond to potential security threats.

• Implement fraud-prevention tools
  Employ advanced fraud-prevention tools, such as address verification service (AVS), card-verification-value (CVV) checks, and 3D Secure authentication, to minimize the risk of fraudulent transactions and chargebacks.

• Monitor transactions
  Regularly monitor and review your payment processing activities for any unusual patterns or signs of fraud. Set up notifications to stay informed about any suspicious activity in real time.

• Maintain clear refund and chargeback policies
  Develop and communicate clear refund and chargeback policies to your customers, to reduce disputes and misunderstandings. Provide comprehensive customer service to resolve issues promptly, minimizing the risk of chargebacks.

• Streamline reconciliation and reporting
  Implement efficient reconciliation and reporting processes to ensure accurate accounting, timely settlement of funds, and effective monitoring of your payment processing activities.

• Stay informed about industry trends and regulations
  Payment processing is perpetually evolving. Keep up-to-date with the latest developments in payment processing technologies, industry best practices, and regulatory changes to ensure your business remains compliant and competitive.

How Stripe Payments can help

Stripe Payments provides a unified, global payments solution that helps any business—from scaling startups to global enterprises—accept payments online, in person, and around the world.

Stripe Payments can help you:

• Optimize your checkout experience: Create a frictionless customer experience and save thousands of engineering hours with prebuilt payment UIs, access to 125+ payment methods, and Link, a wallet built by Stripe.
  
• Expand to new markets faster: Reach customers worldwide and reduce the complexity and cost of multicurrency management with cross-border payment options, available in 195 countries across 135+ currencies.
  
• Unify payments in person and online: Build a unified commerce experience across online and in-person channels to personalize interactions, reward loyalty, and grow revenue.
  
• Improve payments performance: Increase revenue with a range of customizable, easy-to-configure payment tools, including no-code fraud protection and advanced capabilities to improve authorization rates.
  
• Move faster with a flexible, reliable platform for growth: Build on a platform designed to scale with you, with 99.999% historical uptime and industry-leading reliability.
  

Learn more about how Stripe Payments can power your online and in-person payments, or get started today.