Nuts and Bolts: How Payment Processing Works

As a merchant, you know why it’s imperative that you jump on the electronic payments bandwagon. In 2012 alone, Ecommerce sales topped $1 trillion  for the first time, making a leap of 21.1%.

According to Forrester Research, it plans to increase 62% by the year 2016. That’s not too far away for such tremendous growth. ACH processing alone soared past 21 billion in 2012 according to NACHA reports.

The time is now. It’s happening. This is how the world is going to pay.

So you get set up. You order your card reader or sign up for cloud-based software, integrate your systems, market your new option, and sit back. Then, either out of curiosity or prompted by a service call that leaves you guessing, you begin to hear a few foreign terms. “Payment Gateway.” “The processor.” “Acquiring bank.”

You begin to wonder… how on earth does all of this work? It’s a complicated process, involving multiple players and pathways. Let’s break it down.

The Players:

1)      Customer/buyer

2)      Merchant/seller

3)      Issuing bank (customer’s credit card issuer that authorizes or declines transactions)

4)      Acquiring bank (merchant’s underwriting bank that provides the merchant account)

5)      Processor (works in conjunction with the acquiring bank)

6)      Payment gateway (facilitates the route to and from the processor)

7)      Credit card network or interchange (works in conjunction with the issuing bank)

The Flow:

After your customer swipes their card, a flutter of transmissions will ensue. This will get us from the swipe to the approval message, which lets the customer know almost instantly that it’s either a go or a fail. This is the difference between Triple Chocolate Mochachino Bliss or free-water-cup sadness.

The terminal is where your customer swipes or enters their payment information. This can be either physical (your trusty card reader) or virtual (an online checkout page). After the data is entered via the terminal, the payment gateway steps in. The payment gateway will encrypt the sensitive data to avoid security breaches and usher this data along to the processor. The payment gateway will also verify the card data for accuracy.

Once the payment gateway assures all is good, it will hand the data off to the processor. The processor then takes the data to the credit card network, or interchange (Visa, MC, Discover, Amex). This interchange will then ship the transaction off to the issuing bank that provided the customer’s credit card.

The issuing bank then either approves or declines the transaction. It does a quick check on available funds, and then shoots the message back to the interchange. Then back we go. The interchange hands the result to the processor, which passes the torch to the payment gateway.  The gateway taps the terminal on the shoulder and whispers the result, which is your big “Approved” or “Declined” moment. Remember the Triple Chocolate Mochachino Bliss? Now we know what kind of afternoon we’re having.

The process flies by in 2-3 seconds, on average.  This whole journey for our little transaction is called authorization.

Now, there is another process called settlement. This is the journey of the money. It takes typically 3 days to fully “settle,” which is the official term for “getting funded” or “getting paid” for what the customer has agreed to pay.

In the route of settlement, many of our same players are involved. The issuing bank, which has approved the transaction in this case, sends the payment to the interchange. The interchange then facilitates the processor and gateway to deposit the funds into your merchant account. This merchant account isn’t the business bank account where you can withdraw your money. It is a special type of bank account solely for the purpose of gathering these deposited funds first. This merchant account is provided by the acquiring bank. The acquiring bank, once it has the funds in your merchant account, will then push them into the business bank account of your choice. Now you can withdraw your money.

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