According to the US Federal Reserve in 2022, general-purpose card payments reached $153.3 billion transactions and $9.76 trillion in value. On top of that, 69% of Americans online in 2023 said they used digital payment methods to make a purchase.
As a business owner, you just can’t afford to ignore these statistics. You’ll be locking out a significant customer segment with high purchasing power to propel your business forward.
To address evolving customer demands and accept electronic payments, you need a payment processing system. A good system plays a vital role in managing cash flow, alleviating fraud risk, and enhancing customer satisfaction.
But selecting a good payment solution can be overwhelming.
This article dives into what a payment processing system is, how it works, and its benefits. We’ll also look at key features of a payment processor to help you choose the right one for your business.
TL;DR
- A payment processing system is the underlying infrastructure for digital and electronic payments. It ensures the secure transfer of funds from a customer to a merchant via their preferred payment method.
- A typical payment processing procedure involves multiple parties, including the merchant, customer, payment processor, payment gateway, issuing bank, acquiring bank, and card networks.
- To choose the right payment processing solution for your business, you need to evaluate your business needs, evaluate security and compliance standards, and evaluate different payment processors based on pricing, features, customer support, and scalability.
What is a Payment Processing System?
A payment processing system is a technology that facilitates the secure transfer of funds from a customer to a merchant. It’s the underlying infrastructure of digital or electronic payments, ensuring money moves freely and securely via the payer’s preferred payment method to the merchant’s bank account.
Payment processing systems help merchants accept various types of payments, such as credit and debit cards, automated clearing house (ACH), electronic funds transfers (EFTs), digital wallets, mobile payments, and even cryptocurrencies.
The payment processing process involves several key players working together to ensure efficient transactions:
- Merchant – The individual or business accepting payments in exchange for goods or services.
- Customer – The person or business paying for goods or services using a credit card, debit card, or digital wallet.
- Payment processor – The company managing the transaction process. The processor facilitates the transaction by communicating with the payment gateway, issuing bank, and acquiring bank.
- Payment gateway – The service that encrypts and securely sends payment details from the customer to the payment processor and back to the merchant. It links the merchant’s eCommerce store or point of sale (POS) system and the financial networks involved.
- Issuing bank – The financial institution that issued the customer’s credit or debit card. It authorizes or declines payments based on available funds and fraud checks. If the transaction is approved, the issuing bank transfers the money from the customer’s account to the merchant account.
- Acquiring bank – The financial institution that receives payments from the issuing bank on behalf of the merchant. It then deposits the funds into the merchant’s account.
- Card networks – The organizations that govern credit and debit card transactions. They set interchange fees and security standards for processing payments. Popular card networks include Visa, Mastercard, Discover, and American Express.
Keep in mind that a payment processing system isn’t synonymous with a payment gateway and a merchant account.
A payment gateway securely transmits customer data to the payment processor. On the other hand, a payment processing system is the entire infrastructure behind a transaction, which includes the payment gateway.
A merchant account is a bank account that stores business funds from customer payments.
How Does a Payment Processing System Work?
A payment processing system process involves multiple steps and parties. Here’s a step-by-step breakdown of a typical transaction:
- Customer initiates payment – The customer initiates a payment by entering their payment details online, in a mobile app, or a POS system.
- Payment information is encrypted and sent for authorization – The payment gateway encrypts and sends the payment details to the payment processor. The payment processor communicates with the issuing bank and card networks to approve or decline the transaction.
- The issuing bank approves or declines the transaction – If the payment details are correct, the customer has sufficient funds in their account, and there’s no fraud risk, the issuing bank approves the transaction. Otherwise, it’s declined.
- Funds are settled and deposited into the merchant account – Once the transaction has been approved, the funds are deducted from the customer’s account and deposited into the merchant account or payment service provider account after settlement.
Security is the core of any payment processing system. Measures such as encryption, tokenization, and fraud detection are vital for protecting payment transactions from cyber threats, fraud, and data breaches.
Types of Payment Processing Systems
Payment processing systems can be categorized based on how transactions are handled, whether online or in-person and how they integrate with business operations.
Here’s a breakdown of the major types:
Traditional vs. modern digital payment processing
Traditional payment processing systems
Traditional payment processing involves physical card terminals, cash registers, and bank-based transactions. It’s more popular in brick-and-mortar stores since it’s reliable for in-store purchases.
You don’t need an internet connection to process payments traditionally since they involve cash and checks.
Examples of traditional payment processing systems include POS terminals, manual credit card imprint machines, and paper checks processed through banks.
These systems have downsides, including slower processing times and a higher risk of fraud. They also require physical presence for payment.
Modern digital payment processing systems
Modern digital payment processing systems leverage cloud-based technology, APIs, and digital wallets to quickly and securely process transactions. These systems are widely adopted in eCommerce, mobile apps, and contactless payments.
They deliver faster and more secure transactions with automatic approvals. They offer convenience since businesses can accept payments from customers globally, 24/7. While there’s a level of digital fraud risk, most digital payment processing systems have robust security measures, such as encryption, tokenization, and fraud detection.
Examples of modern digital payment processing systems include online payment gateways, digital wallets, QR code payments, and cryptocurrencies.
However, these systems require both the customer and merchant to have an internet connection. Also, some digital payment processing services charge higher fees compared to traditional processing methods.
Online payment processing vs. in-person processing
Online payment processing systems
Online payment processing allows businesses to accept digital payments via eCommerce platforms, mobile apps, and websites. Systems used for this include payment gateways, subscription billing software, and eCommerce platforms with built-in payments.
These systems are ideal for subscription-based and SaaS businesses with global customers. One major advantage is that they automate billing and invoicing.
On the other hand, the type of payments they help process are subject to high chargeback risks. The payment fees also vary depending on the provider.
In-person payment processing systems
In-person payment processing involves physical transactions where customers swipe, insert, or tap their payment method. Here’s how the process works:
- The customer swipes or inserts their card, or taps their card or mobile device
- The POS system communicates with the bank for transaction approval
- The payment is processed and the receipt is generated
These types of transactions are suitable for restaurant, retail, and service businesses. They’re instant and have low fraud risk compared to online payments.
However, they require physical hardware and some providers may have high transaction fees. They’re also less flexible for remote or subscription-based businesses.
Integrated payment systems vs. standalone payment processors
Integrated payment processing systems
Integrated payment systems are built directly into a business’s software or POS system, allowing for seamless transaction management. Popular examples include Shopify Payments, Toast, and QuickBooks Payments.
The system automatically syncs payments with the core business operations. For example, if you offer a SaaS product for inventory management, the system integrates payments to help your users accept payment directly on the software. Payments are processed in the background without manual intervention.
Businesses with integrated payments can track sales, generate reports, and automate bookkeeping, helping them save time and reduce errors.
However, these systems often have higher setup costs. They’re also often limited to specific platforms and switching providers can be difficult.
Standalone payment processors
Standalone payment processors operate independently. They require manual entry or separate reconciliation.
If you wish to integrate a standalone payment processing system, you need to create an account with a payment processor. The transactions are processed separately from other systems. You also have to manually reconcile payments with accounting, inventory, or customer relationship management (CRM) systems.
These systems have a quick setup since no deep integration is needed. They also offer more flexibility in choosing providers and are ideal for small businesses, freelancers, and startups.
However, they’re less automated and require manual tracking of transactions. Also, they may not be the best for high-volume businesses.
Key Features to Look for in a Payment Processing System
Here are some key features to consider when looking for the right payment processing system:
Multi-payment support
A good payment processor should accommodate multiple payment methods to boost customer convenience and maximize sales opportunities. It prevents you from having to run to different payment processing solutions to accept different payment options.
Key payment methods to look for include:
- Credit and debit cards
- Digital wallets
- ACH & bank transfers
- Buy Now, Pay Later (BNPL)
- Contactless & QR code payments
Keep in mind that it’s wise to prioritize multi-payment support even if you don’t need all these options right now. It gives you some flexibility to add new methods down the road as your business grows.
Integration capabilities
A payment processing solution doesn’t work on its own. It’s part of an existing infrastructure and it’s your job to ensure it integrates seamlessly with your website, eCommerce platform, and POS system.
Additionally, ensure the processor works well with other business tools like CRM, enterprise resource planning (ERP), and accounting software.
If an integration doesn’t work smoothly, your payment process will be bumpy and some of your customers may abandon their carts before checkout.
Look for a solution provider that offers clear documentation and integration support to reduce the time and effort needed to configure the system.
Speed of transactions and fund settlement
Payment settlement speed impacts your business cash flow. Different payment solution providers have different settlement times—some are faster than others.
Consider a payment processor with real-time authorization to approve or decline transactions within seconds. Check for faster settlement times, ensuring your business funds are deposited into your merchant account quickly. Ideally, you want instant or same-day fund settlement.
Also, evaluate the provider’s dispute and chargeback resolution speed. Faster resolution speed reduces revenue loss due to fraudulent claims.
Cost structure
All payment gateway providers charge transaction fees. Understanding the costs involved helps you choose the right solution based on your business’s budget. Also, conduct thorough research to avoid overpaying.
Common payment structures adopted by providers include flat rate, interchange-plus, and subscription-based pricing. The ideal pricing structure for your business depends on various factors, such as your business model, your customers’ preferred payment methods, and monthly/annual transaction volumes.
Keep in mind that some providers have hidden fees, such as setup, withdrawal, chargeback, early termination, and PCI compliance fees. Some may also charge you an extra fee if you’re subscribed to a certain plan with a base-level transaction volume and you fail to meet your monthly quota.
Benefits of Using a Payment Processing System
There are multiple tangible benefits of adopting a payment processing system, including:
Faster and more secure transactions
Electronic payment systems automate the entire transaction process. This means they authorize and complete transactions faster than manual processing procedures. Transaction times shrink from days or weeks to a few minutes.
This is particularly important for small businesses operating on tight budgets and can’t afford to wait for extended periods for the funds to be processed.
On top of that, payment service providers have stringent security measures to protect sensitive transaction data. The high-level data security strategies and protocols give you a secure environment to receive payments without compromising customer data.
Also, PCI-compliant payment processors are required to conduct annual security audits by third-party verifiers. They then get certified to prove the company’s trustworthiness.
Increased convenience for customers
Modern customers have high standards. They expect flexible, seamless, and hassle-free shopping experiences. A payment processing system helps you meet their expectations.
It helps your customers make payments anytime, anywhere, from any device, and via their most preferred payment method. This level of convenience boosts your customers’ satisfaction and experience.
On top of that, it improves the customer lifetime value (CLV). This is the total profit your business makes from a certain customer over the course of your relationship.
Improved cash flow management for businesses
Electronic payment options reduce the time spent between the sale and funds settlement, allowing businesses to access funds in their accounts quickly. This enhances business liquidity and financial planning.
Besides, providing real-time reports and analytics helps businesses optimize financial operations and business decision-making.
Also, modern payment service providers often have lower transaction costs compared to traditional banking techniques. For instance, businesses can save on check processing and handling costs.
Lower transaction costs mean more revenue is retained within the business, improving the cash flow.
Reduced risk of fraud and chargebacks
Payment processing systems help reduce the risk of fraud and chargebacks by implementing advanced security measures, authentication protocols, and real-time monitoring tools.
Encryption and tokenization protect sensitive data from online fraudsters by converting sensitive customer data into an unreadable format to prevent unauthorized users from accessing card numbers. 3D Secure (3DS) authentication and AI-powered fraud detection add extra security layers.
They also have chargeback prevention and dispute management tools to resolve issues before they escalate. Merchants get access to representation services to fight false chargebacks with evidence.
Common Challenges and How to Overcome Them
Many businesses face several challenges when adopting payment processing systems. Let’s break down some of these common issues and see how you can address them:
High processing fees
High processing, monthly service, and interchange fees are major roadblocks to implementation for many businesses. These fees can add up over time and reduce profits.
Considering the long-term benefits of accepting credit cards and other payment options is vital. The streamlined financial operations, increased cash flow, and boosted customer retention may far outweigh the costs.
However, also compare different payment service providers and their pricing models before settling for one. If your business receives high transaction volumes, you can negotiate lower fees. Avoid getting into contracts with hidden fees.
If legally allowed, you can surcharge credit card payments and pass some fees to your customers to offset costs.
Chargebacks and fraud
Some merchants consider chargebacks a cost of doing business. However, chargebacks due to fraudulent transactions, disputed purchases, or processing errors have huge negative effects on a business’s bottom line and reputation.
Implement a payment processing service with fraud prevention tools to prevent chargebacks and fraud. Monitor your transactions regularly to identify and block high-risk transactions from suspicious locations or devices.
Also, use chargeback alerts and prevention tools like Verifi and Ethoca to get notifications when chargebacks are filed.
Integration issues
Some payment solutions lack compatibility with POS systems, eCommerce platforms, or accounting software. Payment processors with integration issues lead to operational inefficiencies and diminish the return on investment.
To overcome this issue, choose a processor with well-documented Open APIs that seamlessly integrate with custom applications. If direct integration isn’t available, check whether you can use middleware solutions like Zapier to bridge the gaps.
Most importantly, test the software in a sandbox environment to ensure smooth integration and functionality before going live.
How to Choose the Right Payment Processing System for Your Business
Selecting the right payment processor for your business can be an overwhelming experience. But these tips will set you off on the right foot:
Identifying your business needs
Evaluating your business needs is the first step to identifying what to look for in a payment service provider. Consider how your business operates now and how you would like it to be in the future.
Ask yourself the following questions:
- What’s your industry?
- Does your business operate online, in-person, or both?
- Do your customers prefer paying in-store, over the phone, or online?
- Do you process international payments? Do you expect to receive cross-border transactions in the future?
- What payment volumes do you expect to process?
- Do you offer subscriptions or memberships? Do you need recurring billing and automated invoicing?
- Do you need hardware, like credit card readers or integrated POS systems?
Comparing different payment processors
Once you’ve determined your business needs, compare different payment processors based on the following criteria:
- Pricing & cost structure – Evaluate the providers’ pricing structure and hidden fees to avoid surprises down the road
- Features & integration capabilities – Check whether they have multi-payment support, seamless integration, and customizable APIs
- Customer support & reliability – Look for 24/7 support availability, multi-channel support, a history of high reliability, and ease of dispute resolution
- Scalability – Can the system handle high transaction volumes? Can it support new payment methods as your business grows?
Evaluating security and compliance standards
Security is a core factor when choosing the right payment processor. A good system should protect both your business and customers from data breaches, fraud, and regulatory penalties.
Key security features to look for include PCI DSS compliance, encryption & tokenization, 3DS authentication, and chargeback prevention tools.
On top of that, check for compliance with local and global regulatory and industry standards, such as GDPR, PSD2 & SCA (for European transactions), and HIPAA (for healthcare businesses).
Conclusion
A payment processing system isn’t just another business tool. It’s the backbone of your business cash flow—streamlining your financial operations and bolstering seamless electronic payments.
Key features to look for in a payment processing solution include multi-payment support, integration capabilities, payment and settlement speed, and cost structure. Compare different payment service providers based on these features.
Before committing to a contract with any provider, you need to understand business needs. Evaluate your current and future business to choose a suitable solution in the long term.
Also, choose a PCI-compliant payment processing solution that prioritizes security for both your business and customers. This is where Stax comes in. Our solutions are geared toward helping small businesses, large enterprises, and software platforms streamline their payments.
Request a demo today and access turnkey solutions that improve your customers’ experience and propel you toward growth.
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