Most of us use credit cards – on e-commerce websites as well as physical stores. However, not many people understand the working of a credit card and the elements involved in moving funds from their account to the merchant’s. In this article, we explain that process (for online transactions specifically).
Types of transactions
Credit card processing includes a set of transactions. These are explained below:
- Preauth transactions: In a preauth, the validity of the credit card is verified. The charge for preauth is typically around $1.
- Postauth transactions: In these transactions customers place an order and the product is shipped at a later date. At the time of order, a card hold is applied on the customer’s card. The merchant applies a postauth to transfer the funds after the order has been shipped, also releasing the card hold.
- Credit transaction: This is the transfer of funds from the merchant’s account to the customer’s.
- Sales transaction: In a sale transaction, the customer makes a purchase and uses the card to transfer funds from their account to the merchant’s.
- Chargeback transaction: Chargebacks are cases where the customer disclaims a charge to her card. In such a dispute, the bank withdraws the amount from the merchant’s account and deposits it in the customer’s account till the issue is resolved. The merchant is given some days to prove their case. If they can satisfy the bank with evidence, the amount is transferred back to the merchant. Each chargeback costs the merchant as banks levy a charge for the time and effort involved.
Prerequisites for accepting online credit card payments
You need to have the infrastructure to accept credit card payments on your business website. The requirements are:
- a Card Not Present merchant account
- an account with a gateway such as AuthorizeNet, CyberSource, WorldPay, etc.
- a Vital Tear Sheet to submit to the gateway (provided by the bank)
- a relationship with credit card types such as American Express; to be informed to the gateway
- a SSL enabled server
Steps in online processing of credit card transactions
We focus on the processing of a sales transaction. This is how it works:
- The customer places an order by filling a form that collects the card details. On submitting the form, the details are sent to the server.
- The server processes the information received and directs it to the appropriate software installed on it for card verification.
- The software verifies the details provided by the customer. If it is valid, it sends the information to the gateway for further checks.
- The gateway validates the card and the availability of funds. Based on the result, it sends an “approved” or “declined” message back to the software. The gateway charges the merchant a fee for this service which can be a fixed monthly rate or a per transaction rate.
- Gateways route the transactions to designated clearinghouses (selected by the bank for a credit card type) in batches.
- The clearinghouse receives transactions from multiple gateways, batches them for various banks and transfers funds accordingly. Again, this service comes at a fee that ranges between 2%-5% of the cumulative sale.
- The clearinghouse transfers funds from the customer’s bank to the merchant’s bank.
- On receiving the transaction, the merchant’s bank transfers the amount from the customer’s account to the merchant account. Again, the bank or card issuing company will charge a set of fees for various services – setting up the merchant account, discount rate, chargeback fee, etc.
As you can see, credit card processing isn’t so baffling after all. However, because of the various roundabouts involved in the process, businesses prefer to pay a credit processing company to manage the services instead of taking on the task themselves. With the fall in processor rates, this also makes sense financially.