Credit card processing – the basics: how it works, what it costs and best practices

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  1. Introduction
  2. What is credit card processing?
  3. Key components of credit card processing
  4. How credit card processing works
    1. 1. Transaction initiation
    2. 2. Authorisation request
    3. 3. Transaction authorisation
    4. 4. Authorisation response
    5. 5. Transaction completion
    6. 6. Settlement
  5. Credit card processing providers
  6. Credit card processing costs
  7. Credit card processing best practices

With the rapid growth of e-commerce and the diversification of payment methods, it has become increasingly important for businesses to adapt to new ways of conducting transactions. According to a 2023 survey conducted by Forbes Advisor, only 9% of Americans rely primarily on cash for their purchases. Just over half of those surveyed (54%) prefer to use either a physical or virtual debit card, while 36% opt for a physical or virtual credit card as their primary payment method.

By adopting advanced payment systems, businesses can provide simple, secure and efficient transactions which increase revenue and enhance the customer experience. Below, we'll discuss the important aspects of credit card processing, including the key components that power the system, as well as credit card processing fees. We'll also look at proven strategies for building and maintaining a high-performing credit card payment system. Here's what you need to know.

What's in this article?

  • What is credit card processing?
  • Key components of credit card processing
  • How credit card processing works
  • Credit card processing providers
  • Credit card processing costs
  • Credit card processing best practices

What is credit card processing?

Credit card processing is the system that enables businesses to accept credit card payments from their customers. By facilitating easy, secure transactions, credit card processing broadens the range of payment options available to customers and increases sales.

Key components of credit card processing

Credit card processing involves several components that work together. Here is an overview of the main players involved:

  • Cardholder
    The cardholder is the customer who owns a credit card issued by a bank or financial institution.

  • Merchant
    The merchant is the business or individual that sells goods or services and accepts credit card payments.

  • Acquiring bank
    The acquiring bank, or acquirer, is the financial institution that partners with the business to process credit card transactions. The acquiring bank receives transaction information from the business and communicates with the issuing bank to obtain authorisation.

  • Issuing bank
    The issuing bank, or issuer, is the bank or financial institution that issues the credit card to the cardholder. The issuing bank approves or declines transactions based on factors such as the cardholder's available credit and account status.

  • Card networks
    Card networks are organisations – such as Visa, Mastercard, American Express and Discover – that provide the infrastructure and rules for processing credit card transactions. Card networks act as intermediaries between acquiring banks and issuing banks to facilitate transaction communication, authorisation and settlement.

  • Payment gateway
    A payment gateway is a tool that transmits payment information from the business's point-of-sale (POS) system or e-commerce platform to the acquiring bank for processing. It encrypts the cardholder's data and ensures that the transaction complies with security standards.

  • Payment processor
    A payment processor, or payment-processing provider, is a company that manages the transaction process on behalf of the acquiring bank, handling tasks such as communicating with payment networks, obtaining authorisation and managing the settlement process.

  • POS system
    A POS system is the hardware and software used by businesses to accept credit card payments. For in-person payments, this might include a card reader or a retail terminal. For online transactions, this would include the e-commerce platform and payment gateway.

These parties ensure that credit card transactions are secure, efficient and comply with regulations and industry standards, providing an easy and fast payment experience for customers and businesses.

How credit card processing works

Credit card processing includes a series of steps that give businesses the ability to accept credit card payments and process those payments. Here's an overview of the process:

1. Transaction initiation

The customer provides their credit card information to the business, either by swiping, inserting or tapping their card at a POS terminal, or by entering their card details on an e-commerce website or mobile app.

2. Authorisation request

The payment gateway transmits the payment information securely, encrypting the data before sending it to the business's acquiring bank. The acquiring bank forwards the transaction details to the appropriate payment network to start the authorisation process.

3. Transaction authorisation

The payment network routes the transaction to the issuing bank, which verifies the cardholder's account, checks for available credit or funds, and assesses the risk associated with the transaction. Based on these factors, the issuing bank either approves or declines the transaction.

4. Authorisation response

The issuing bank sends the authorisation response – either an approval or a decline code – to the payment network, which forwards it to the acquiring bank. The acquiring bank relays the response to the payment gateway, which ultimately passes it on to the business's POS system. At this point, the business receives the approval or decline message.

5. Transaction completion

If the transaction is approved, the business provides the goods or services to the customer. The approved transaction is added to a batch of other transactions awaiting settlement.

6. Settlement

At the end of each day or another predefined period, the business submits the batch of approved transactions to the acquiring bank. The acquiring bank requests funds from the issuing bank through the payment network. The issuing bank transfers the required funds to the acquiring bank, which deposits the money into the business's account, minus any fees associated with credit card processing.

Typically, authorisation takes a few seconds and settlement takes a couple of days. See here for more details about Stripe's payout timelines for businesses.

Credit card processing providers

When choosing a credit card processing provider, businesses should consider several factors to ensure that they select the right partner for their needs:

  • Assess your business needs
    Understand your transaction volume, average transaction size and whether you require in-person, online or mobile payment processing. Consider every market, audience segment and channel where you currently do business or plan to expand into. You'll need a payment provider that accepts all the preferred payment methods and currencies in these areas.

  • Compare pricing and fees
    Processing providers may charge various fees, including transaction fees, monthly fees, setup fees and hardware fees. Compare different providers' pricing structures to determine which one offers the best value for your business. Read here about Stripe's payment processing fee structure.

  • Evaluate customer support
    Issues with your processing system can affect your sales and customer experience directly. Make sure that you choose a provider that offers reliable customer support. Here are more details about the various channels where Stripe customers can access support 24 hours a day, 7 days a week.

  • Consider security and compliance
    Ensure that the provider complies with the Payment Card Industry Data Security Standard (PCI DSS) and other relevant security standards to protect your customers' sensitive data and minimise the risk of fraud.

  • Review integration compatibility
    Check if the provider's payment-processing solution is compatible with your existing POS system, e-commerce platform and accounting software to ensure that integration is as seamless as possible and that future operations run smoothly.

  • Research provider reputation
    Look for reviews from other businesses to gauge the provider's reputation and reliability. Consider asking for recommendations from your industry peers. While it's advisable to be aware of new payment-processing options and approaches, it's also important to partner with a vetted provider.

  • Analyse additional features and services
    Some providers may offer value-added services, such as advanced reporting, recurring billing or multicurrency processing. Determine which features are necessary for your business and which would be a nice addition.

Carefully evaluating these factors and comparing different credit card processing providers is the best way for businesses to make an informed decision that suits their requirements, budget and long-term goals.

Credit card processing costs

Credit card processing costs can vary depending on the provider, transaction type and other factors, so it's important to understand what credit card processing fee structures look like for different payment processors. Common costs associated with credit card processing include:

  • Transaction fees: These are fees that the payment-processing provider charges per transaction. They are usually expressed as a percentage of the transaction amount, plus a fixed fee. For example, Stripe charges 1.5% + £0.20 for each successful card charge (for UK cards).

  • Monthly fees: Some providers charge a monthly fee for their services, which may include access to a payment gateway, reporting tools or other features.

  • Setup fees: Some providers charge a one-off setup fee for creating and configuring your account.

  • Terminal or equipment fees: If you require physical equipment to accept payments in person, such as a card reader or POS system, there may be costs associated with purchasing or leasing this hardware. This is especially important point for businesses that need to accept in-person payments at scale to consider.

  • PCI-compliance fees: Some providers charge an annual fee for maintaining PCI compliance or assisting your business in achieving compliance.

  • Chargeback fees: If a customer disputes a charge, you may be subject to a chargeback fee, which is typically a fixed amount for each disputed transaction. These fees tend to be more for high-risk businesses or those with a history of high chargeback ratios.

Credit card processing best practices

With cashless transactions on the rise, businesses should take a strategic approach to credit card payments. By carefully considering their payment processing systems and practices, businesses can reduce costs, minimise risks and enhance the customer experience. Businesses that need to create a frictionless, secure and integrated credit card payment system should follow these best practices:

  • Align your approach to your sales channels
    There isn't a one-size-fits-all credit card processing strategy for every use case. For example, a platform business supporting a large number of users that need to accept in-person credit card payments in a number of global markets will have different requirements to an e-commerce retailer that doesn't operate any in-person sales channels. Understanding your specific needs will allow you to uncover the best options for your business.

  • Implement fraud-prevention measures
    Most credit card processing solutions have fraud prevention built in. However, businesses still need to make sure that they are protected against fraud, depending on where and how they conduct transactions. You can use basic tools – such as address verification service (AVS) and card verification value (CVV) checks – in addition to advanced fraud-detection software to minimise the risk of fraudulent transactions.

  • Monitor and analyse transactions
    Review your transaction history on a regular basis to detect unusual patterns, identify potential issues and refine your processing strategy. Make sure that your payment processor offers this type of monitoring. Stripe Radar uses machine learning to detect and prevent fraudulent transactions.

  • Create clear and accommodating refund and chargeback policies
    Establish transparent and fair refund and chargeback policies to reduce disputes, maintain customer satisfaction and avoid unnecessary fees.

  • Offer multiple payment options
    Cater to a wide range of customer preferences by providing multiple payment options, including credit cards, debit cards, digital wallets and other alternative payment methods. This doesn't mean that you need to accept every payment method. Instead, conduct research into how your customers prefer to pay and which payment methods are most commonly used with the types of products and services that you offer.

  • Maintain up-to-date hardware and software
    Keep your POS systems, payment gateways and other processing components updated to ensure smooth operations, enhanced security and improved customer experiences.

To find out more about how Stripe can power a credit card processing strategy that accommodates every customer segment, channel and market where you do business, get started here.

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