The Ultimate Guide for Small Business Credit Card Processing

Updated on January 5, 2022

the ultimate guide for small business credit card processing

Credit Card Processing (Short Overview)

Credit card processing is highly important to every business today. Evidence shows that providing the convenience of credit transactions accelerates business growth by over 40% (Merchant Warehouse, 2014).  Again, only 10% of today’s customers in the US rely on cash. So installing a credit card payment solution is a must-have.

At its core, we can say that credit card processing means making your business accept payments by card machine. But it goes beyond that.

Installing the right credit card payment solutions will speed up and automate payments, reduce manual processes, accelerate cash flow, empower your staff and drive more revenue.

But then choosing an upgraded payment processing system comes with confusing terms and fees. There’s also the possibility of getting rejected due to poor personal credit. Sure you can always fix the latter with the proper IRS forms to clear your financial records.

But beyond that upgrade, you need to maximize the benefits of your chosen credit card processor. This is why many small businesses admit that the most confusion on their financial statements comes from credit card processing.

Even as there are benefits, there are risks to consider. For instance, you must take note of security risks for buyers and chargeback risks for sellers. But again newer credit card technologies have better credit card risk management solutions.

Therefore, we have created this guide to help you understand the world of card payments by machines. Here you will learn to determine the best credit card processing solutions for small businesses. You will also learn how to choose the right card terminals suitable for your budget. That way, you can maximize the benefits of credit card processing, implement the right credit card processing strategies and keep your costs as low as possible.

Credit Card Processing Solutions; Terms & Basics

Credit card processing involves numerous terms, concepts, and parties.  So understanding these elements gives you an idea of how payment processing works.

Merchant Account

A “merchant account” is parallel to your personal bank account. But instead, it holds the financials for your business. This is where you can review, accept, and process all your credit transactions. You will open this merchant account under a Credit Card company. This allows them to easily intervene if fraud or any disputes occur.

Point of Sale (POS) System

A Point of Sale System is the equipment that you use to conduct transactions for your business. For instance, all of your sales may go through a cash register, credit card reader, and receipt printer. Or, you may have a more advanced POS system that tracks inventory or generates sales reports. These tools for purchase make up your POS System.

Payment Gateway

A Payment Gateway is a secure online portal where buyers enter their private payment information. After the gateway receives the information, it then processes it to complete the sale.

Types of merchant account and payment processing solutions

As a merchant, your ideal credit card processing solution must best fit the mold of your business. To decide, you must consider factors such as security or cost.

 But you shouldn’t consider these variables in a void. Instead, they depend on whether you’re a brick and mortar establishment; an online marketplace; or involved in –or open to– mobile commerce. In short, how you process payments relies on who you are as a company. And will influence the payment solution you choose.

Brick and Mortar Establishments:

Brick and mortar brands may opt to have a traditional processing solution. So you might combine a simple POS System (such as a cash register and receipt printer) with a credit card reader. The credit card reader connects to your merchant account and registers every purchase and sale.

So here you can enter credit card information and streamline payment processing. And from there, your bank account can process all payments from this single funnel.

Online Marketplaces:

Online credit card processing requires a payment gateway. Here, the payment gateway substitutes the credit card reader. So, it would serve as the tool that forwards all buyer information to your merchant account.

As the technology behind your check-out page, payment gateways offer optimal functionality when paired with a web shopping cart.

But here’s where price comes in. Online transactions unfortunately run a higher risk of identity fraud. This is because there’s no room for any personal verification between the buyer and the seller. Due to the security risk, web-based credit card solutions may be a more costly option.

Mobile Commerce:

Mobile commerce is an integrated credit card processing solution. So here, buyers can conduct mobile payments via online transactions or in-store technologies. In other words, customers can either use Wi-Fi to access an online marketplace on their cell. Or they can download simple smartphone applications to replace credit card swipes.

Mobile commerce solutions may come with other integrated solutions that appeal to merchants. A good example is invoicing software paired with virtual payment gateways.

It is popular for B2B companies to consolidate two or more processing solutions. But then, this depends on how you define your business identity.

Each credit card processing solution has its unique way to transfer payment information to a merchant account. From there, we process it into our bank accounts. When the natural flow of payments is already in place, the only question that remains is what route do you choose to take to get there. And, in the end, each business must travel down the path that is best paved for its model.

Credit Card Processing Rates & Fees

 

Many businesses find it challenging to understand credit card processing rates and fees.  To navigate your processing fees, you need to know:

  • The ‘who’s’ (parties involved)
  • The ‘how’s’ (the different payment processes that influence the costs)
  • The ‘what’s’ (the rates that define each transaction type)

The “Whos”

It’s important to understand whom you’re dealing with when it comes to credit card rates and fees. Becoming familiar with the characters involved will help you better grasp the story.

Credit Card Associations:

The credit card associations are the major players in the payment processing world. They set the stage and they direct the industry. Think Visa, MasterCard, and American Express.

Credit Card Issuing Banks:

Credit card issuing banks supply the financial value to the credit card associations. This means if they don’t create and issue their own cards like AmEx and a few other associations do.  Think Chase, Citi, and Wells Fargo.

Credit Card Processors/Acquiring Banks:

Acquirers liaise between vendors and credit card associations. They ease transactions by sending the necessary information to the credit card associations and by authorizing merchant requests. Anyone transaction may need any number of acquirers. For instance, a business may encounter separate acquirers for financial statements, IT support, and money issuing.

Merchant Account Providers:

These companies manage credit card processing (e.g. sales, support, etc.), usually through the help of an acquiring bank. They can be either financial institutions, independent sales organizations, or double-duty acquirers; depending on the situation. Again, your merchant account is more or less your business’s personal bank account.

Payment Gateways:

Payment gateways are the secure payment forms used in online transactions. With payment gateways, processing fees are accrued as payments are wired from this portal to the acquiring bank.

The “Hows”

When interpreting credit card processing costs, it is useful to translate these expenses into simplified terms.

So, you can describe processing rates and fees as “taxes” levied on each transaction by the parties listed above. Oftentimes, rates combine a percentage of the sale and a flat fee per transaction. What you’re selling, where it’s sold, and how it’s purchased can influence your processing fees.

For all rates and fees, there can be two subcategories attributed:

  1. wholesale and
  2. markups.

Wholesale describes the universal, objective fees of your business’s transactions, paid to your issuing bank and your credit card association.

Markups describe the varying, subjective fees paid to your chosen payment processor.

The “Whats” (Rates)

Discount Rate:

The discount rate is defined by how the payment was transacted and what type of merchant account you have. It is the most basic expense of credit card processing. This rate covers the time and costs that it takes to process and deposit your credit and debit card payments from your business’s merchant account and into your personal bank account.

The discount rate is initially charged by merchant account providers, who calculate the cost from a certain portion of your total bill along with an additional fee per transaction. On top of this, merchant account providers charge a markup for use of their platforms.

Similarly, issuing banks, dues, and assessments contribute to extra, conditional costs charged by the credit card associations (such as 2.10% + .10). These extra costs are known as “interchange rates”.

Surcharge Rates:

Your qualified, mid-qualified, or non-qualified rates are determined by the type of card being processed. So, the different card types include credit cards, business cards, corporate cards, international cards, and reward cards.

At the time that a transaction is accepted through an approved credit card processing solution, then a qualified rate is charged. This rate is often the lowest and therefore the rate that is generally referred to when describing processing rates.

At the time that a transaction is accepted through a processing solution that does not qualify for the lowest processing rate, then a mid-qualified rate is charged. Examples include when a credit card number is keyed in as opposed to swiped, or when a company card is used as opposed to a personal card.

At the time that a transaction is accepted through a processing solution that neither qualifies for the lowest nor the non-qualified rate, then this rate is charged. Examples include lack of verification or unauthorized payments.

The “Whats” (Fees)

In the world of credit card processing fees, there are three spheres:

  • transactional,
  • flat, and
  • incidental.

Types of Transactional Fees: Debit Transactions and PIN Based Fees:

As for the discount rate, transactional fees are the most basic and primary as they are charged with each sale.

Transactional fees are determined by the risk of the transaction (i.e. they are higher in CNP transactions than they are in in-person, swiped payments). Because of the risk, transactional fees are therefore charged with or without payment approval.

These are the fees charged to the processing companies with each transaction conducted with a debit card. Processing debit cards can cost anywhere from 0.2% – 2.0% of the purchase (as opposed to the 1.5% – 4.0% of credit cards), plus an additional flat fee that ranges from $0.11 to $0.25 per sale (whereas the additional range for processing credit cards begins at $0.20).

The exact amount depends on the size of the issuing bank. And, typically, cards requiring a personal identification number (PIN) are fixed.

Types of Flat Fees:

Flat fees represent the costs of your (the merchant’s) purchases, such as signing up for a merchant account. Some are monthly and others are one-time charges. They include:

  • Application/Setup Fee: The initial charge to set up your merchant account. (This is a generally outdated fee).
  • Terminal Fee: The charge of in-store credit card purchases, applicable only for brick and mortar establishments.
  • Payment Gateway Fees: The charge of online credit card purchases, applicable for only e-commerce marketplaces.
  • Payment Card Industry (PCI) Fees: The charge for not complying with standards, or the standard fee for complying with regulations.
  • Annual Fees: These are fees charged every year to cover the basic use of a provider’s services. In my opinion, this is a bogus fee. Most of the better merchant account providers will not charge it.
  • Early Termination Fees: The charge for canceling a merchant account before the contracted end date.
  • Monthly Statement/Service Fees: The charge for call centers – such as customer service or account assistance.
  • Monthly Minimum Fees: The charge for businesses that do not achieve minimum monthly or yearly transaction amounts, which typically is expected to reach an annual total of $50,000. This is another fee that is not charged by some of the better providers like Dharma Merchant Services.
  • Statement Fees: The charge of printing & mailing bills, which can be avoided with electronic billing.
  • Online Reporting Fees: The charge of electronic billing, which is typically not charged or is packaged together with another fee.
  • IRS Report Fees: The charge of 1099-K (reporting purchases for tax purposes), typically from $2 to $5 depending on the provider.
  • Network Fees: The charge of certain card networks.

Types of Incidental Fees:

Incidental fees are conditional costs resulting from certain processing activities, such as chargebacks. They only occur under certain conditions, but the activity charged is important to prepare for. Unlike transaction fees based on a percentage of each payment and fixed fees based on a flat rate, incidental fees are not affected by the quantity or quality of the transaction. Some types of incidental fees include:

  • Internet Gateway Fees: Additional transactional fees charged for securing transactions conducted through online marketplaces.
  • Address Verification Service (AVS) Fees: Additional transactional fees charged for online marketplaces and telephone order businesses.
  • Voice Authorization Fees (VAF): The charge for authorizing transactions with the use of a toll-free call center.
  • Retrieval Request Fees: The charge for the retrieval request that you issue when disputing a chargeback. This will typically cost between $10-$50.
  • Chargeback Fees: The charge for chargebacks, varying with circumstances.
  • Batch Fees or “Automated Clearing House” (ACH) Fees: The daily charge for transferring funds from your merchant account to your personal bank account.
  • Non-Sufficient Funds (NSF) Fees: The charge for personal funds that are so insufficient that they cannot afford merchant account fees.
  • Downgrade Fees: The charge for non-qualified rates due to risk increases, typically caused by unauthorized or unverified transactions.

Credit Card Processing Pricing Models

As you can see, credit card processing fees and rates vary from business to business, and from month to month. The most important thing is to expect the expenses you’ll run into and to know your way around your statements.

Not every credit card processing pricing model is created equal. The options are as dynamic as business types and sales volumes themselves. So at the core, there are four main processing models available:

  1. The Tiered Model = fixed percentage of each transaction + markup fee based on the credit card used
  2. Blended Model =  fixed percentage of each transaction
  3. interchange-plus = fixed rate for merchant account + markup fee based on each transaction
  4. The Subscription/membership = fixed percentage of each transaction + fee for each transaction

The tiered model or “tiered pricing system”

This is a pricing plan that charges the merchant a certain fixed percentage for each transaction, along with an additional markup fee based on the qualified level of the credit card used in that 1 transaction.

As previously discussed in the rates & fees section, every credit card transaction can be qualified, mid­qualified, and non­qualified.

The less qualified the credit card transaction, the higher the markup fee. Since ‘qualified,’ ‘mid­,’ or ‘non­qualified’ is subjective to the payment processor, the tiered model is often the least transparent of the four. In other words, it’s the model with which it is most difficult to expect your monthly statements.

In other words, this model is the most difficult to anticipate your monthly statements.

The blended model

The blended model is a pricing plan that charges the merchant only a certain fixed percentage for each transaction. Unlike the tiered model, the type of credit card used will not influence this charge.  It does not also involve other additional fees.

Though a consistent blended rate is high, it is generally not charged monthly. This is why the blended model is best for businesses with low sales volumes.

The interchange plus model

This model charges the merchant a fixed rate for the merchant account and an additional markup fee based on each transaction.

Like the blended model (and unlike the tiered model), the interchange-plus plan does not change according to the credit card used in the transaction.

The unique aspect of the interchange plus model is that its margins stay constant. So every business pays rates only proportionate to its sales volume.

Besides, the interchange plus system conveys which fees are wholesale (meaning, the fixed rate for your merchant account) and which fees are markups on your statement. This is why this system may be the most transparent model of the four.

The subscription/membership model

This charges the merchant a fixed rate for the merchant account, and an additional fee for each transaction.

Similar to the blended and the interchange plus models (and unlike the tiered model), the subscription/membership plan does not change according to the credit card used in the transaction.

This processing pricing option is unique in that there are no percentage markups charged. Hence, it is popular among big businesses carrying out a lot of sales.

As you can see, some of the most notable differences between these four credit card processing plans are their varying ratios of wholesale rates to markup fees.

In other words, these models range from completely wholesale rates (subscription/membership) to rates that combine wholesale rates and markup fees (tiered and interchange plus), to rates that are completely markups (blended).

So, your business’s financial standing, sales volume, and pricing solution may need a certain ratio over another.

And as every business is unique, so is the model that works best for you. 1

Other markup fees you might pay include payments to the bank, to the credit card company, and the merchant account.

Credit Card Processing Refunds

Refunds are inevitable in any business, and the trick is to handle them with care. Why? Because refunds are not simply a mark of a good level of service for your customers, they’re also a sign of a bill ahead for you.

As a merchant, your bill for each refund depends wholly on your credit card processing company.

Some processing companies reimburse the merchant’s account for the amount the customer is requesting back, but charge businesses a small fee.

Other credit card processing companies will not reimburse the merchant’s account for the amount the customer is requesting back, and they will charge businesses both a transaction fee and a processing fee for the transaction.

It’s important to note that credit card processing companies do not accept refunds indefinitely. Instead, there is typically a 60 to 120 day limit for an exchange. Additionally, merchants may not be able to access their reimbursed funds for up to six weeks.

Again, all these factors depend on the credit card processing company. So this is an important aspect to consider when choosing your processor or when deriving your business’s refund policy.

Credit Card Processing Fraud, Disputes, and Chargebacks

There will always be customers challenging charges – whether those challenges are valid or not. Yet, you need to be able to recognize red flags and most of all, reduce them. First, to best identify the potential merchant account culprits (i.e. fraud, dispute, chargeback), let’s put a name to who’s who:

  • Fraud: wrongful or criminal deception intended to result in financial gain.
  • Dispute: a situation in which a customer questions the validity of a transaction that was registered to the account.
  • Chargeback: a demand by a credit­card provider for a retailer to make good the loss on a fraudulent or disputed transaction.
  • Friendly Chargeback: a demand by a customer for a retailer to make good the loss on a seemingly fraudulent transaction or a regretful purchase.

As you can see, the main differences in these situations are the various actors and intentions with which any given charge is challenged.

  • In a fraudulent occurrence, the customer is acting with malice
  • in a dispute, the customer is acting along suspicious activity;
  • and in a chargeback, the credit ­card provider is acting according to dues.

Don’t also forget the “friendly chargeback” phenomenon, in which the customer is acting according to remorse or by mistake.

Now that we’ve identified our perps, let’s get into how to help you, the merchant, and potential victims.

The two main concerns when it comes to credit card processing fraud, disputes, and chargebacks are

  • how to protect against them and, when the unfortunately inevitable issues arise,
  • how to resolve them.

How to Protect Against Credit Card Processing Fraud and Chargebacks.

When we’re talking about protection, we can disregard protection against disputes. These things do happen and should come at no cost to you.

In other words, if customers dispute a charge, then they’re essentially reporting personal fraud on their personal accounts (and your goods happen to be the target of that personal fraud).

If the customers’ disputes render true, then the credit card processor will handle the fraudulent activity (see the “refunds” section for how this will be handled).

If not, then no harm, no foul. Thus, the focus should be on protection against fraud.

And, as fraud is the trickiest of the three processing sticky situations (due to its inherent deceit), it’s most important to narrow the window within which fraudulent transactions can occur.

Here are your surefire ways to keep your guard up, guns blazing:

1. Ask for as much verification as possible

This may include

  • Requesting photo identification for in-­person transactions
  • Requesting the three-­digit verification credit card code (CVV code) for online transactions
  • Implementing captcha for online transactions,
  • Asking for the buyers’ contact phone numbers or email addresses attached to their accounts for all types of transactions.

2. Implement new credit card payment technologies

As you can see, not all of the preventative measures of verification requests above are traditional (i.e. captchas), and there are always new technologies working to improve your credit safety. In addition to identification techniques, there are recent developments in payment processing that can only work in your favor if you are aware of them:

A good example is EMV credit cards. These cards create advanced microchip technology that allows the credit card at hand to communicate with the credit card reader on the spot.

3. Keep your eyes peeled

Within­-store transactions, you have the power to use your presence as security. In other words, take advantage of the fact that customers are buying in your brick and mortar establishment by visually checking their receipt signatures and their card numbers

4. Take extra precautions

Sometimes, it’s better to rely on a third­ party for your funds’ security. For one, you can store all buying and selling data and records on another computer besides your own. Or, you can require that online buyers input a ZIP code and street address into their payment gateway that matches with the Address Verification Service (AVS) and their credit card accounts.

5. Go the extra mile

Besides using a third­ party system other than your own, take it one step further by implementing tokenization.

Tokenization is the security solution that renders credit card numbers unreadable after they’ve been input into your system. Thus warding off hackers and later, fraud.

6. Think ahead

When developing your business’s policies, lean towards credit card­-only solutions, such as implementing a rule that you’ll accept credit card refunds only (as opposed to cashback refunds, too). By leading customers to credit card associations, you’re adding an extra level of security, verification, and fact­checking from the side of these bigger corporations.

7. Follow the rules

This one’s simple, if you adhere to PCI requirements, you’re less likely to encounter fraudulent activity. As mentioned before, these seven security precautions protect against fraud (and therefore, against disputes, as well). However, chargebacks are important to take individual note of as well, though less threatening as they are often done with a more innocent intention than fraudulent charges.

Unless, of course, we’re talking about friendly chargebacks.

How to protect against card payment chargebacks (friendly or otherwise)

1. Request written confirmation

While we’ve already addressed requiring signatures as a verification method against fraudulent activity, a signed receipt can also be used as evidence that the buyer both indeed purchased and intended to purchase your inventory.

2. Educate yourself on your options

Major credit card associations, such as Visa, are constantly developing verified methods of substantiating proofs of purchase. Not surprisingly, the higher amount of evidence required the lower number of friendly chargebacks faced by businesses. Since Visa’s new update, they’ve reported a 20% higher success rate for merchants disputing friendly chargebacks (Verifi).

Other preventative measures for you to consider include:

  • mixed media verification, such as photo identifications and e-mail addresses for in-store transactions
  • IP addresses
  • geolocation, and
  • device identifications for online transactions.

Each of these modes’ requirements for purchases can provide another layer of evidence that your consumer is in fact responsible for what has been consumed.

3. Prepare for the worst

In some cases, a buyer is aware of the transaction but is too ashamed to own up to the charge as it appears on their credit card billing statemen