If you’re interested in taking credit card payments for your small business but not sure where to start, this guide is for you.

The following entities are central to how credit card processing works to securely capture payments at the point of sale.

Consumer. The cardholder, or the person making the purchase.

Merchant. The person or business selling the product or service the consumer is purchasing.
Payment gateway. The technology that connects a merchant to a payment processor. Typically, a gateway integrates with card-present (e.g., in-store purchases) as well as card-not-present (e.g., online or eCommerce) payment environments, captures payment details for customer transactions and routes them to a payment processor or the merchant bank, and sends an “approved” or “declined” message to the merchant.

Credit card processor. Also known more generally as a “payment processor.” The entity that facilitates communication between the merchant, the credit card network, and the cardholder’s bank. Processors, along with merchants, are responsible for maintaining compliance with the Payment Card Industry Data Security Standards (PCI DSS). Some payment processors provide their own payment gateways, while others, typically the larger processors, have reseller agreements with payment gateways.

Card network. Also referred to as the “credit card network” or “credit card brand.” This is the brand of the customer’s credit card, such as American Express, Visa, Mastercard, or Discover. The credit card networks are responsible for setting interchange and assessment fees, as well as the standards for PCI DSS.

Issuing bank. Also referred to as the “cardholder’s bank” or “consumer bank.” This is the bank that provides the customer with their credit card. One of the primary functions the issuing bank serves in the credit card processing cycle is to determine whether the cardholder’s account holds the funds to complete a transaction, and to release those funds for settlement.

Acquiring bank. Also referred to as the “merchant bank.” This is the bank used by the merchant to hold their business funds and receive money from transactions. It can provide the merchant with card readers and equipment to accept card payments. The acquiring bank can also serve as a credit card processor.

* Please note that “merchant bank” and “merchant bank account” should not be confused with the similarly named “merchant account.” A merchant account, typically created by a merchant services provider, is an account that temporarily holds the funds from processed credit card (and debit card) purchases. As the merchant, you do not have direct access to this merchant account—it is simply a holding account for these funds, which are transferred to your business banking account once the settlement process completes.

Credit card processing starts at the consumer level: the customer initiates a payment with their credit card, and the payment information is shared with the merchant.

The merchant accepts and collects the payment information, in one of two ways: a.) in person as a “card-present” transaction or b.) online or via telephone as a “card-not-present” transaction.
Next, the payment information is sent to the credit card processor, who sends it to the card network.

The card network then passes the payment information to the consumer (issuing) bank.

The consumer bank is responsible for verifying that the cardholder has sufficient funds or credit to complete the transaction. The bank may also run security protocols to ensure the purchase is legitimate. It then approves or declines the transaction, and communicates that decision through the credit card processor. The three most common reasons for a declined transaction are a.) insufficient funds; b.) credit limit reached; c.) unauthorized purchase (e.g. if the card has been reported lost or stolen).

If the transaction passes the consumer bank’s verification processes, the funds are released from the consumer bank to the merchant account, and subsequently enter the settlement process (see step 8).

Meanwhile, the notification travels back from the consumer bank to the point of origin of the sale, and typically results in a message on the card reader or the virtual terminal that tells the merchant whether the transaction has been “approved” or “declined.”

The final step in the process is settlement, which can take several days depending on the card network involved in the transaction. Settlement is the official transfer of the transaction amount from the consumer bank to the merchant bank, less applicable processing fees.

As described above, assuming a transaction is approved, the funds are transferred from the cardholder’s bank to the merchant account. Once settlement completes, they’re sent to the merchant bank account. Depending on your payment processing terms and the frequency with which fees and other charges are deducted, the amount of the sale or transaction may not reflect the amount of the actual bank deposit.
To learn more about bank deposits, check out our guide.

Credit card processors typically charge a processing fee for every credit card payment you accept. Depending on your processor, you may be charged additional fees depending on what pricing model the processor uses.

Transaction fees can be broken down into two primary kinds: wholesale and markup. Wholesale fees, also known as “interchange” fees, are charged by the issuing bank and the card network. Markup fees are charged by the credit card processor and the payment gateway. Unlike wholesale fees, markup fees can be negotiated.

There are three types of credit card processing fees you should be aware of:

Interchange Fee. The interchange fee is the wholesale fee mentioned above. This is a standard, non-negotiable fee that covers the costs of processing the transaction, the risk of payment approval, and the risks of fraud and bad debt. Collected by the consumer (issuing) bank, the interchange fee is a percentage of the purchase total plus a set transaction fee that’s determined by each card network. This fee represents the largest cost of credit card processing, and is typically impacted by the type of credit card involved in the transaction. The average interchange rate in the U.S. is approximately 1.8% for credit cards and 0.3% for debit cards, but the actual rate a merchant will pay varies greatly. For example, interchange fees on premium or rewards cards are generally higher.

Assessment or Service Fee. This is another non-negotiable fee, but this time it’s the card network that charges it. This fee is typically a small percentage and can be affected by your transaction volume and your risk level as assessed or calculated by the card networks.

Processing Fee. Each payment processor charges their own fees. This is known as the payment processor markup, and it varies depending on the pricing plan of the processor.

Payment processors leverage a variety of pricing models. These are the four you are likely to come across when selecting a payment processor:

Flat rate. The processor charges a simple fixed fee for all credit and debit card transactions regardless of the card used for payment. Note that card-present transactions often have a lower flat rate than card-not-present transactions, as they carry less risk. This can be structured as a simple base rate (for example, 2.9%), or a base rate plus a small per-transaction amount (for example, 2.9% + $0.30 per transaction). This model merges the wholesale and the markup fees instead of splitting them out.

Tiered. The processor charges a fee based on the card type used in the transaction, how much risk is associated with the transaction, and the overall transaction volume of the business. This model is considered to be the most complex and potentially most confusing to merchants.
Interchange Plus. The Interchange Plus is the most common pricing model, and often considered the most transparent and cost-effective. Here, the merchant is charged a percentage of the transaction plus a fixed per-transaction fee. In this way, the wholesale fee (the “interchange” part) and the markup fee (the “per transaction” part) are distinctly and clearly separated. For example, a $100 payment made with a Visa Rewards credit card might carry a total (effective) rate of 2.13%, which includes the interchange fee, the card network fee, and any other fees charged by the credit card processor.

Subscription. The processor charges a flat monthly service fee, along with a small per-transaction fee. The wholesale fee is charged separately from the markup fee.
No matter which pricing model your business selects, note that not all transactions clear at the same rate. A qualified transaction will process at a lower rate than a non-qualified transaction.

As with any service your business utilizes, credit card processors do offer additional services you might want to consider as you determine which processor is best for you. For example, the processor might give you:

• Credit lines, loans, or other advances
• Payroll management
• Inventory organization
• Employee management
• Customer engagement programs