How does payment processing work? (2024)

If you own a business, it’s important for you to understand the basics of payment processing. You want to be able to receive payments smoothly, but it’s not just about that.

You’re responsible for your customers’ private financial information as soon as they enter their payment details on your site, so you want to be as informed as possible about the process in case any issues ever come up.

I’m going to explain exactly what happens behind the scenes when a customer makes a purchase, to give you a good understanding of the full picture. I’ll also tell you about the best ways to accept payments on your website.

{{text-box}}

What Is Payment Processing and Why Do You Need It?

Payment processing is a general term used to describe the sequence of processes that take place behind the scenes of electronic transactions. These transactions can be via credit card, debit card, or any other digital payment method.

If you want to sell on your own website, whether you’re selling goods, services, or subscriptions, you’ll need a way to accept credit cards and other payment methods. You’ll need the infrastructure to allow smooth and secure transactions.

Accepting online payments can be risky. There’s always the possibility that a card is stolen or counterfeit. Cybercriminals are lurking everywhere, looking for opportunities to turn a profit by taking advantage of unsuspecting merchants.

A payment processor can take care of all of this for you. When someone pays you with a credit card, the processor verifies the authenticity of the card and handles all communication between any involved banks and credit card companies.

How Does Payment Processing Work?

Payment processing happens in 3 steps: authorization, authentication, and settlement. Let’s take a closer look at each one.

‍

Authorization

For a credit or debit card transaction to go through successfully, the card details must be verified and authorized. This step ensures that the customer’s card is valid and legitimate. Here’s how it works:

1. The customer enters their card information on a website checkout page or inserts their card into a POS terminal at a brick-and-mortar business.
2. The card details are encrypted and sent to the acquiring bank.(the seller’s bank).
3. The acquiring bank sends the card details to the credit card association (e.g. Visa, Mastercard, or American Express).
4. The credit card association approves the payment request and asks the issuing bank (the customer’s bank) to authorize the transaction.
5. The issuing bank authorizes the transaction once it verifies the card number, expiration date, security code, billing address and total payment amount.

During this process, it is the payment processor that handles the communication, asking the banks and card associations for authorization. Although this sounds like a lot of steps, it generally only takes a few moments to complete.

Authentication

Once the issuing bank is satisfied that the card details are verified, it authenticates the purchase so the payment can be released to the acquiring bank. Here’s what happens during this stage:

1. The issuing bank gives the credit card association its approval.
2. The credit card association passes on the authorization to the acquiring bank.
3. The issuing bank puts a temporary hold on the customer’s account in the amount of the purchase. Once the transaction clears, these funds will be withdrawn and deposited in the seller’s account.
4. The customer sees a confirmation message on the checkout page or receives a hard copy receipt in a brick-and-mortar business.

If the issuing bank does not approve the transaction for any reason, it will notify the card association and acquiring bank and the transaction will be canceled. The customer will see an error message, usually explaining the reason for the rejection.

Settlement

In the final stage of payment processing, the issuing bank releases the funds and they are transferred to the seller’s account in the acquiring bank. It can take a few days for the transaction to settle and for the seller to see the funds. Here’s what’s going on in the background:

1. At the end of each day, all approved authorizations from the day are sent to the acquiring bank.
2. The acquiring bank passes this information on to the credit card association.
3. The credit card association works to settle each individual transaction, which involves getting the funds to the seller, removing the hold from the customer’s account, and finalizing the transaction.
4. The credit card association sends the issuing bank notice of all approved transactions.
5. The issuing bank transfers the funds to the credit card association.
6. The credit card association passes the funds on to the acquiring bank.
7. The acquiring bank deposits the funds in the seller’s account.
8. The issuing bank deducts the funds from the customer’s account and closes the transaction.

How You Can Optimize Your Payment System to Grow Your Revenue

The best businesses are always looking for ways to enhance their revenue growth. Here are a few key ways to optimize your payment system to increase your number of sales.

Speed Up the Checkout Process

Today’s online shoppers expect a fast and easy checkout process. According to the Baymard Institute, most sites can reduce the number of form fields displayed by 20% to 60%.

With Pay.com, you can securely store your customers’ details and payment preferences so returning customers don’t have to reenter all their information. This way, you can create a faster online payment process, reduce cart abandonment, and increase your conversion rates.

Make Sure Your Checkout Process Is Mobile-Friendly

According to the Global Mobile Shopping Study from Verto Analytics and Yotpo, 36% of mobile users in the United States have made an online purchase using their mobile in the last six months. Nearly 40% of those users made a mobile transaction every week during that time!

This is why it’s so important to customize your checkout page and make sure it works smoothly on smaller screens. It’s also a good idea to accept mobile-friendly payment methods such as Google Pay and Apple Pay.

Put an Emphasis on Security

With cybercrime on the rise, it’s becoming increasingly important for consumers to feel safe when paying for something online. In fact, a lack of visible security is one of the leading causes of cart abandonment.

Pay.com uses the 3D Secure protocol that provides an additional layer of security. You can show the 3D Secure symbol and other security logos throughout your checkout process to increase trust and confidence.

Provide a Range of Payment Options

Offering local payment options is an excellent way to build trust with customers and increase your sales. While credit cards like Visa, Mastercard, and Amex may be popular in the US, this is not necessarily true in other markets like China and certain parts of Europe.

Pay.com lets you accept a wide range of payment methods on your website. You can integrate payment methods from all around the world, even if your business is registered in the US.

Payment Processing Terminology

As a business owner, it’s a good idea to be familiar with the key terms involved in payment processing:

• Credit card processing: A system that enables credit card data to be transmitted through an electronic card network. The system validates and approves transactions and transfers funds between accounts.

• Debit card processing: Similar to credit card processing, but less complex, and typically takes place on different networks. As a merchant, you can usually accept both credit and debit cards using the same software (and hardware, if applicable).
• ACH transfers: Automated Clearing House (ACH) is a network run by the National Automated Clearing House Association (NACHA). It enables the routing of payments between banks and can be used for money transfers, recurring payments to pay back debt, paycheck deposit, and more.
• Mobile payment systems: Also known as mobile or digital wallets, these platforms allow users to make payments on their mobile devices without having to enter their credit card details each time. A couple of well-known examples are Google Pay or Apple Pay.
• Payment processor: A company that enables merchants to accept payments and processes those payments for them.
• Payment gateway: Basically, an online version of a point-of-sale (POS) terminal. It’s a front-end software application on a merchant’s website that enables online payments. Payment gateways capture and send credit card data to the payment processor and communicate approvals or rejections.
• POS (Point of Sale) terminal: A system consisting of hardware and software that enables brick-and-mortar merchants to accept credit and debit transactions. The hardware usually includes a computer and several connected devices, such as card readers and receipt printers.
• Merchant bank (acquirer): A financial institution a merchant can use to accept customers’ debit and credit card payments.
  
• Card issuer: A financial institution that provides credit and debit cards on behalf of card networks such as Visa, Mastercard, and American Express.
  
• Credit card network: A company that facilitates the connectivity between the merchant bank and the card issuers.There are four main card networks: Visa, Mastercard, Discover, and American Express.
• Address Verification System (AVS): A service provided by credit card networks to verify whether a cardholder’s official billing address in the card issuer’s system matches the billing information entered by the customer. This process helps reduce online payment fraud and chargebacks.

How to Protect Yourself from Fraud

Every day, billions of dollars are processed around the world. While most transactions run smoothly, there are some potential issues to be aware of. The biggest issue is fraud, which can end up costing you huge amounts of money.

There are a few steps you can take to mitigate the risk.

• Choose a payment processor that offers PCI-compliant data security and protection, such as Pay.com. You don’t need to be a cybersecurity expert, but you definitely want to be sure that your payment processor is using all the latest protections.
• Require your customers to provide their billing address, card expiration date, and CVV (card verification value) code. The more data you ask for, the less opportunity there is for fraudulent behavior.
• Use SSL (secure sockets layer) certificates and other security measures like 3DS2 to protect the safety of all transactions on your online store. Most payment processors will require the use of SSL certificates for any ecommerce merchant that they work with.
• Make sure all of the hardware and software that you use is up to date and that all of the latest patches and security updates are installed.

The Bottom Line: How to Choose a Payment Processor

It’s important to do your research to find the best payment processor for your business. You’ll want to make sure the service you choose can help you accept a variety of payment methods in addition to credit cards and debit cards.

As discussed above, security is extremely important when it comes to online transactions, so always go with a PCI-compliant payment processor. Ask questions about the fraud prevention elements your processor has in place.

Pay.com provides a complete payment infrastructure that allows you to accept payments on your website. It’s easy to set up and get started, even if this is your first time selling online. It comes with the latest security features and fraud protection technology, giving you peace of mind.