How to handle credit card chargebacks: a guide for small businesses

A chargeback is a dispute of charges filed by a customer and their credit card company or bank. It’s an obstacle that can challenge a merchant’s customer relationships and their accounting process, sometimes resulting in fees or loss of income. Unfortunately, many merchants will have to deal with a chargeback claim at some point. If your business receives a notice of dispute from a credit card company, you may have to prove the validity of your charges. You may also be responsible for fees associated with the chargeback process.

Receiving payments electronically is a way of life for most businesses. Here, we’ll explain what chargebacks are, why they occur and how you can handle them effectively. Read on for an in-depth look at chargebacks, or use the links below to skip ahead to the section that best fits your query.

• What is a chargeback?
• How do chargebacks benefit consumers?
• How can chargebacks affect merchants?
• Why do chargebacks happen?
• The chargeback process
• How to deal with chargebacks
• Tips for avoiding chargebacks
• Final notes

What is a chargeback?

A chargeback happens when a customer contacts their credit card issuer or bank to dispute charges they’ve incurred after shopping with a particular merchant. Charge disputes are usually filed if the customer believes they have encountered fraud or merchant error. When their financial institution processes the dispute, they will extend a temporary credit to the cardholder’s account and “charge back” the transaction amount to the merchant.

After the business receives notice of the chargeback, they’ll have the opportunity to respond to the credit card company or bank. When responding, a business either accepts the chargeback or appeals it with evidence that the dispute is not valid. The chargeback may be dismissed or drawn out, even if the merchant’s documentation is accurate.

If the customer chooses to proceed with their dispute claim, the chargeback can span several accounting periods, which complicates the accounting process.

How do chargebacks benefit consumers?

Because chargebacks were designed as a method of consumer protection, they offer several benefits to consumers that use credit cards .

Peace of mind

Chargebacks give consumers peace of mind because they know that if they encounter fraud or merchant error, they won’t be responsible for taking on the burden of these costs. Knowing that they can buy from a merchant without having to worry about these threats allows consumers to shop comfortably.

Protection against criminal fraud

If a criminal gets hold of a cardholder’s information, chargebacks offer protection against fraudulent transactions that may occur as a result.

How can chargebacks affect merchants?

While chargebacks offer consumers a great deal of protection and peace of mind, they can have adverse effects on merchants.

Chargeback fees

Chargeback fees are implemented when a merchant accepts a chargeback claim or a card issuer determines that the merchant is at fault. A chargeback fee is imposed by banks in an effort to recover incurred costs while handling consumer chargebacks and disputes associated with your account. Chargeback fees tend to range from $20 to $100 and are usually categorised as operational expenses.

Loss of revenue

When merchants receive a chargeback, they’re not only held responsible for associated chargeback fees, but they’re also responsible for the lost revenue and merchandise. As you can imagine, this can be extremely damaging to your business over time.

Bank account termination

If chargeback rates continue to exceed the appropriate level, the acquiring bank can close the merchant account. This means that your merchant account has been frozen and your right to process credit card payments has been revoked. Merchants who have a closed merchant account are unable to accept credit cards.

Why do chargebacks happen?

Understanding why chargebacks occur not only helps you deal with them, but also prevents them from happening in the first place. Let’s take a look at the reasons chargebacks might occur.

Clerical errors

Clerical or merchant errors are one reason a customer may file a dispute with their credit card company. Perhaps they were billed for an item that they didn’t purchase, or maybe they were billed for the incorrect amount. Merchant mistakes can happen for a number of reasons, like improper training or simple human error. We’ll discuss how small businesses can prevent these types of errors later on in this post.

Friendly fraud

“Friendly fraud” refers to customers contacting their bank or credit card issuer to file a dispute instead of seeking a return or refund directly from the store. This may occur if the customer is unfamiliar with return processes or they don’t know the difference between a regular refund and a bank-forced refund. However, friendly fraud can also be a result of customers knowingly taking advantage of loopholes in the chargeback process. For example, a customer could theoretically make a purchase and dispute the charge so they can be refunded and keep the item for free.

Unrecognised or forgotten purchases

Sometimes consumers simply forget they made a purchase or don’t recognise the charge on their credit card statement, which also falls under the umbrella of friendly fraud. This often happens with recurring payments for subscriptions and other purchases the cardholder doesn’t pay attention to. As a result, they may choose to file a cardholder dispute with their financial institution to protect their credit score and financial standing.

Quality complaints

Another form of friendly fraud has to do with quality complaints. If a customer places an order and finds that it doesn’t meet quality standards, they might use the chargeback system to address the issue.

Credit card fraud

Credit card fraud or “true fraud” occurs when a criminal steals a cardholder’s identity and makes unauthorised purchases on their behalf. In cases of identity theft, the cardholder could dispute the charges, limiting their responsibility for the fraudulent charges.

How do chargebacks work? Understanding the chargeback process

There are several steps in the dispute process:

1. Consumer files a chargeback

The chargeback process begins when a consumer files a dispute with their bank or credit card issuer. The cardholder will identify the charge and explain the issue they encountered. This could be merchant error, friendly fraud or credit card fraud. After the chargeback has been filed, the card issuer posts a preliminary credit to the cardholder’s account.

2. The issuer assigns a reason code to the chargeback

The credit card issuer—which could be their bank, Visa, Discover, Mastercard or American Express—will then assign a reason code to the chargeback claim. Chargeback reason codes identify the reason the cardholder filed a chargeback, which can include friendly fraud, merchant error or credit card fraud. Depending on the reason code, chargeback disputes may have different time limits.

3. The issuer investigates

To obtain additional information, the issuing bank sends a retrieval request to the merchant’s bank. If the conflict can be settled, the acquiring and issuing banks do so. Otherwise, the acquiring bank sends a chargeback notification to the merchant.

4. The merchant reviews the chargeback

Once the merchant receives notice of the chargeback they have the option to accept the claim and the chargeback fees or contest the claim. If the merchant chooses to contest—known as chargeback representment—they have to provide evidence that they fulfilled the credit card transaction accurately. From there, the card issuer reviews the information and makes their final decision. Sometimes, the arbitration period can last for months if both parties keep going back and forth.

How to deal with chargebacks

Chargebacks can be an expensive headache for business owners. It’s a good idea to learn about the process and how to deal with chargebacks efficiently and effectively.

Don’t ignore chargebacks: act as quickly as possible

As we mentioned, merchants have the option to either accept or dispute a chargeback once they are notified that a claim has been filed. If they choose to accept, they assume responsibility for the chargeback. If they contest, they have to provide supporting evidence to the card issuer. If the merchant chooses not to respond, the consumer wins by default and the merchant is responsible for the disputed credit card charge and associated fees.

Contact your customer before contesting

Before you decide to contest the claim with the card issuer, it’s helpful to try to work through the issue with your customer first. In some cases, they may not have realised they could get a full refund, and together you can sort out the issue.

Provide documentation if you do challenge it

If you decide that you’d like to move forward with a chargeback dispute, make sure you have the appropriate documentation to support your case, such as:

1. A receipt
2. Proof of shipping
3. Matching bill-to and ship-to addresses
4. Proof of delivery
5. Communications with the customer that show you fulfilled the request.

Tips for avoiding chargebacks

While not all chargebacks are avoidable, there are steps you can take to prevent circumstances that may trigger a chargeback claim.

Reduce merchant errors

Humans make mistakes—that’s a reality of life and business operations. Unfortunately, these mistakes can be costly to your business, especially if you encounter chargebacks. To minimise the potential for merchant errors, consider investing in a robust point of sale (POS) system. A POS system that handles pricing and calculates change automatically reduces your room for error and, ultimately, lowers the likelihood of chargebacks.

Watch for potential fraud red flags

Watching for red flags that signal potential fraud is another way to prevent chargeback cases. Here are a few red flags to look out for:

• Exceptionally large orders
• Repetitive orders
• Different shipping and billing addresses
• Repetitive orders from the same IP address
• Guessing the expiry date
• Typos
• International shipping

Create clear billing descriptions

Merchants can address the issue of friendly fraud by creating clear billing descriptions. This way, the customer will know what to expect when they place an order and what the charge will look like on their statement. Sharing this information can prevent unrecognised charge claims from appearing as chargebacks.

Process refunds quickly

Some consumers use chargebacks as an alternative to in-store refunds, which can be a big inconvenience to merchants. To minimise this outcome, make sure you have a good refund policy in place to process refunds and returns as quickly as possible. This will not only reduce the potential for chargebacks but also help you maintain positive relationships with your customers.

Keep customers informed

Keeping customers informed throughout the purchase process can help establish trustworthy relationships and, in turn, help you avoid chargebacks. Make sure that customers are aware of your return process, billing descriptions and customer service options with every purchase.

Final notes

Chargebacks are a frustrating part of the sales process. They can cost your business a lot of time and money, depending on how you approach them. You may not be able to avoid chargebacks completely, but there are steps you can take to prevent them and handle them appropriately when they do occur.

Whether you run an e-commerce business or a bricks-and-mortar store, bookmark this guide to help you put proactive steps in place and navigate the chargeback process. Having a streamlined, accurate payment system can help you keep customers informed, prevent fraud and even process returns.

Learn more about how QuickBooks solutions can help your business today.