Payment processing is important for businesses of all sizes, including small businesses. US businesses paid a record $187.2 billion in processing fees in 2024 to accept payments from credit, debit, and prepaid cards. Below, we’ll discuss what small businesses should know about payment processing, including how it works, some challenges and risks, how to choose the right payment provider, and how to create a flexible payment strategy.

What’s in this article?

• How does payment processing work for small businesses?
  
• Types of payment processing systems for small businesses
  
• Key components of small business payment processing
  
• Why is effective payment processing important for small businesses?
  
• Challenges associated with payment processing for small businesses
  
• How to choose a payment processing provider for your small business
  
• Payment processing best practices for small businesses
  
• How Stripe Payments can help
  

How does payment processing work for small businesses?

There are three steps to the payment processing cycle:

• Transaction initiation: A customer decides to make a payment using a credit or debit card. The customer’s card details are captured via a point-of-sale (POS) system, an online payment gateway, or another card-accepting device.

• Authorization: The card details are sent to the payment processor, which forwards the transaction details to the card-issuing bank for authorization. The bank checks the card’s validity and whether the customer has sufficient funds or credit. If everything is in order, the bank sends an authorization code to the payment processor and the transaction can proceed.

• Settlement: The authorized transaction is batched with other transactions to be processed, usually at the end of the business day. The payment processor facilitates the transfer of funds from the card-issuing bank to the business’s account. The business’s bank credits the business’s account with the transaction amount, minus any transaction fees.

To maintain security throughout this process, payment processors use encryption and compliance standards such as the Payment Card Industry Data Security Standard (PCI DSS).

Types of payment processing systems for small businesses

There are two primary types of payment processing systems for small businesses.

Merchant account providers

These are financial institutions or companies that provide businesses with merchant accounts, specialized bank accounts that businesses must have to accept credit and debit card payments. Merchant account providers offer more control over the payment process but often involve more complex setup procedures and fees.

Payments service providers (PSPs)

PSPs like Stripe aggregate merchant accounts, allowing businesses to accept payments without setting up their own merchant accounts. PSPs are generally easier to set up and use, and are a popular choice for small businesses.

Key components of small business payment processing

The key components of electronic payment processing—the payment gateway, merchant account, and payment processor—work together to facilitate digital transactions. Here’s what small businesses should know about these pieces of the payment processing system.

Payment gateway

A payment gateway is a service that authorizes and processes payments in online transactions, and acts as a bridge between a business’s website and the payment processor. When a customer makes a purchase, the gateway securely transmits the payment information to the processor for authorization and completion. Additional features, such as fraud protection, encryption, and tokenization, keep transactions secure.

Here’s how it works:

• Data encryption: When a customer enters their payment details on a website, the payment gateway encrypts the data before transmitting it.

• Authorization request: The gateway sends this information to the payment processor, which forwards it to the card-issuing bank for authorization.

• Response transmission: The gateway receives the approval or decline response from the payment processor and transmits this information back to the business’s website.

Merchant account

A merchant account is a type of bank account that allows businesses to accept and process electronic payment card transactions. After a card transaction is authorized, funds are held in a merchant account before they’re transferred to a business’s regular bank account. Here’s what to know about merchant accounts:

• Funds holding and transfer: After a transaction is approved, the funds are temporarily held in the merchant account. These funds are transferred to the business’s bank account, typically within a few days.

• Relationship with acquiring banks: Merchant accounts are provided by acquiring banks or financial institutions that have relationships with card networks like Visa and Mastercard.

• Fee structures: Merchant accounts can involve a variety of fees, such as transaction fees, monthly fees, and potential penalty fees, which vary depending on the provider.

Payment processor

A payment processor is a company that manages the credit card transaction process by acting as a mediator between the business, the business’s bank (acquirer), and the card issuer (customer’s bank). Payment processors play an important role in the payment system in the following ways:

• Transactions: They handle the technical aspects of processing credit and debit card transactions, which includes sending transaction data to the appropriate card networks and banks.

• Fraud prevention and security: Payment processors employ security measures to prevent fraudulent transactions and comply with industry standards such as the PCI DSS.

• Settlement of funds: Processors facilitate the settlement of funds so the business receives payment for transactions, minus fees.

These three components work together to enable electronic transactions. The payment gateway captures and encrypts the card information, the merchant account acts as a holding area for the transaction funds, and the payment processor completes the transaction by facilitating the movement of funds.

Why is effective payment processing important for small businesses?

There are many reasons why small businesses should prioritize payment processing:

• Faster transactions for better cash flow: Small businesses tend to operate with limited resources. Fast payment processing means they receive money quickly, improving their ability to manage daily expenses.

• More payment methods for a better customer experience: Customers expect a variety of payment options, including credit cards, online payments, and mobile payments. By meeting these expectations, small businesses can improve customer satisfaction and encourage repeat business.

• Improved accuracy of accounting and recordkeeping: Automated payment processing helps maintain accurate financial records. This is important for tracking sales and managing inventory, and for tax purposes. Correcting errors in manual processing can be costly and time-consuming.

• Increased security to keep customer data safe: Digital payment methods are generally more secure than cash because they reduce the risk of theft and fraud. Keeping customer and business finances safe is a key aspect of business relationships.

• Expansion of global reach: For businesses that want to expand geographically, electronic payment systems allow them to accept payments from anywhere in the world, opening up new markets and customer bases.

• Reduced administrative paperwork: Electronic payments reduce the need for paper-based invoicing and recordkeeping, which saves time and reduces environmental impact.

• Better management of recurring payments: For businesses that operate on subscription models or need to manage regular billing, automated payment systems simplify the process by guaranteeing timely, regular payments without the need for constant manual intervention.

• Lower overhead for handling other payment types: While there are costs associated with setting up electronic payment systems, accepting these options can be more cost-effective overall than handling cash or checks. They eliminate bank deposit fees, the labor involved in manual processing, and the need to physically transport money. Processing digital payments costs 57% less on average than processing nondigital payments.

• Better data for analysis and insight: Many payment processing systems come with analytical tools that offer insight into sales trends, peak purchasing times, and customer behavior. This insight can inform business strategies and marketing efforts.

Challenges associated with payment processing for small businesses

Payment processing for small businesses presents its own set of challenges, including the following:

• Costs: Transaction fees, rental fees for equipment, and charges for payment gateway services can add up, especially for small businesses with thin profit margins.

• Fraud and security risks: Maintaining the security of customer data and transactions is an ongoing concern for small businesses, which often lack the resources to invest in premium security measures.

• Technical issues and reliability: Issues such as software glitches, hardware malfunctions, and internet connectivity problems can disrupt the ability to process payments, leading to lost sales and customer dissatisfaction.

• Compliance and regulations: Small businesses must remain compliant with standards such as the PCI DSS to avoid penalties and legal issues, which requires time and knowledge of regulatory requirements.

• Chargebacks and disputes: Managing chargebacks involves paperwork and ongoing communication with banks and customers, and can result in lost revenue.

• Integration with other systems: Integrating payment processing systems with other business software (e.g., accounting or inventory systems) can be challenging, and the lack of integration can lead to inefficiencies and errors in recordkeeping.

• Consumer preferences: Keeping up with developing consumer payment preferences (e.g., mobile payments, digital wallets) requires continual updates and possibly additional investment in new technologies.

• Limited bargaining power: Small businesses often lack the bargaining power to negotiate lower transaction fees with payment processors, unlike larger businesses that can use their high transaction volumes for better rates.

• Training and support: Training staff to use payment systems effectively can be a challenge if the business lacks the resources for extensive training or the payment processor provides limited support.

• International transactions: For businesses that work with international customers, additional challenges include currency exchange, higher transaction fees, and international payment regulations.

How to choose a payment processing provider for your small business

Selecting a payment processor requires balancing immediate transactional costs against your long-term operational scaling. Here are some steps you can take to assess providers:

• Evaluate your operational baseline and growth plans: Review your average monthly sales volume and typical transaction sizes and list preferred payment methods. Choose a payment processor that aligns with your specific business model, and ensure that the vendor will be able to scale for your future needs.

• Identify the ideal processor architecture: Decide whether your business needs a traditional merchant services provider or a simplified payments service provider like Stripe. Look for providers that seamlessly combine card processing with an integrated online payment gateway. Choosing an all-in-one option simplifies your software environment and prevents compatibility issues between your checkout page and your backend bank deposits.

• Audit the true cost of ownership and contract flexibility: Find the per-transaction cost by checking whether the provider levies flat monthly maintenance charges, minimum processing volume penalties, or separate account statement fees. Additionally, prioritize providers with flexible contracts (e.g., month-to-month options instead of multiyear contracts) and check the contract for early termination penalties, security policies, and other details.

• Verify platform performance through reviews and testing: Research active business experiences on neutral third-party review platforms and small business networks. Request access to a free developer sandbox or software demo. If possible, deploy the new payment system in a real-world pilot, such as on a single digital product line or at one secondary cash register.

• Conduct a side-by-side final selection: List your top three processing choices in a direct comparison table. Weigh baseline transaction costs against platform features, technical uptime histories, and the constant availability of live customer technical support. If your business has significant sales volume, use your processing history to negotiate custom pricing metrics or lower monthly hardware costs before you sign a final agreement.

Once your chosen system is live, schedule biannual audits of your merchant statements. Regularly cross-reference your actual effective processing rates against your business growth to ensure your provider still delivers optimal value.

Payment processing best practices for small businesses

Here are some important payment processing best practices for small businesses:

• Offer multiple payment options: Include a variety of payment methods such as credit and debit cards, digital wallets (e.g., Apple Pay, Google Pay), and online payments platforms so you can cater to a wide range of consumer preferences. If you serve international customers, consider offering payment methods that are popular in those regions and check whether your processor can handle multiple currencies.

• Prioritize security and compliance: Choose a payment processor that complies with the PCI DSS. Employ payment gateways with strong encryption and security protocols to protect sensitive data during transactions. Update your payment processing software and hardware routinely to protect against the latest security threats.

• Simplify the checkout process: A simple checkout process helps reduce cart abandonment. Minimize the number of steps and make navigation as intuitive as possible. Don’t forget to refine your payment process for mobile users.

• Implement fraud detection and prevention measures: Use address verification services (AVS) when possible to verify customers’ identities. Require that customers enter the card verification value (CVV) during credit card transactions to reduce the risk of fraudulent use. Regularly review transactions for suspicious activities and set up alerts for unusual patterns.

• Provide clear payment information and support: Display prices, taxes, and fees clearly so customers know exactly what they’re paying and why. Respond promptly to customers’ payment-related inquiries and issues. Customers should be able to locate your contact information quickly and easily.

• Use analytics and reporting tools: Use analytics tools to monitor sales trends, peak transaction times, and customer purchasing behavior. Reconcile your transactions regularly, and use reporting tools to track financial health and for tax purposes.

• Continually review and update payment processes: Keep up-to-date with the latest trends in payment processing, including new payment methods and technologies such as cryptocurrency. Train your staff on your payment processing system and any new updates to it.

• Plan for business continuity: Implement backup payment processing options in case your primary system crashes. Back up transaction data regularly to prevent loss in case of system failures. Regularly assess the effectiveness of your payment processing system and make adjustments as needed.

How Stripe Payments can help

Stripe Payments provides a unified, global payment 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 payment 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.