What is a payment processor? A guide for small businesses

Deciding on how to accept customer payments is just one of many decisions that business owners need to make when starting a business. To accept customer payments, you’ll need to decide on a payment processor.

If you don’t yet know anything about payment processors, you might assume it’s the payment device that sits beside the cash register. But while that’s a completely understandable assumption, it’s not entirely accurate. Never fear—this article contains everything you need to know about payment processors, payment gateways, and more.

What is a payment processor?

A payment processor is a company that handles your business’s credit card processing so customers can buy your products. They’re the go-between party making sure your customer’s money makes it from their bank to yours. A payment processor’s job is to relay the information from your customer’s credit or debit card to your bank and vice versa.

An example of a payment processor’s work is making sure there’s enough money in the customer’s account to cover the cost of the purchase. If there is, the transaction goes through. If there’s not, the customer’s card may be denied—and that information is all relayed almost instantaneously in real time.

What is a payment gateway?

A payment gateway, on the other hand, is the tool that transmits card data to the payment processor. An example is the EMV card reader that sits beside the register, gathering the customer’s payment information. This information could come from someone physically swiping their credit card, or from a contactless payment made via a mobile device or smart watch.

And payment gateways can be virtual tools too, transmitting ecommerce or online payments. In this case, payment gateways are basically online point-of-sale (POS) terminals for your small business.

Payment gateways vs. payment processors

Payment gateways and payment processors are different. You may be wondering if you have to choose one over the other, but the fact is they work together toward the same goal.

To recap, your payment processor is the company that facilitates your transactions. Your payment gateway is the tool that communicates transaction messages between you and your customer, including whether the payment is accepted or declined.

Some companies offer services and products to fulfill both payment processor and payment gateway needs. For instance, QuickBooks Payments offers customers multiple payment gateways (including a free mobile card reader and a “pay now” option on invoices). But the product also acts as a payment processor, sending transaction information between your bank and your customer’s bank.

What is a merchant account?

A merchant account is the account customer money goes into prior to being automatically transferred into your small business bank account. You need one in order to process credit cards.

Here’s how it works: Your customer makes a purchase, using their debit or credit card. The money goes into a merchant account, where it’s processed by a third party or the merchant account company. While the money is in the merchant account, you cannot access it. Once the money is fully processed (about 1-2 days later), the funds are deposited into your business checking account.

You can get a merchant account through a merchant services provider or from a payment service provider (PSP). Common PSPs include PayPal, Square, Stripe, and even QuickBooks Payments.

How does payment processing work?

Here’s how payment processors work when your customer pays in-store, through a credit card transaction.

1. A customer comes into your store and wants to make a purchase, using their credit card.
2. You ring up their items, and at checkout they insert their card into your payment gateway (i.e., card reader).
3. All payment information (including the amount the customer pays and their card number) is encrypted by the payment gateway and payment processor. This helps with fraud prevention and data security.
4. The payment processor analyzes the transaction and makes sure your customer has the funds needed to make their purchase. Messaging is sent back to the payment gateway to approve or deny the transaction.
5. The payment processor tells your merchant services provider or bank to credit your account for the transaction.
6. The money goes into your merchant account and is then deposited into your business’s bank account 1-2 days later.

If the customer were paying with a debit card, the last few steps would change slightly. Rather than the customer’s credit card company sending funds to the business owner’s merchant account, payments are made directly. Once the payment is approved, money is sent from the customer’s bank account to the business’s bank account.

Payment processing and ecommerce

If the transaction is online, the steps are essentially the same, even if some parts are less physically visible:

1. A customer comes to your website and wants to make a purchase, using their credit card.
2. They enter their payment information into your payment gateway, or the place on your site where they type in their credit card number and other details.
3. The payment gateway encrypts their payment information and sends it to the payment processor.
4. The payment processor analyzes the transaction and makes sure your customer has the funds needed to make their purchase. Messaging is sent back to the payment gateway to approve or deny the transaction.
5. The payment processor tells your merchant services provider or bank to credit your account for the transaction.
6. The money goes into your merchant account and is then deposited into your business’s bank account 1-2 days later.

How do payment processors make money?

Payment processors make their money via transaction fees (you’ll soon find there are a lot of fees associated with accepting digital payments).

Every time you process a payment —whether it’s approved, declined, a chargeback or a refund— the payment processor charges an authorization fee. There may also be setup fees, termination fees, and monthly fees. And, if your payment processor is also your merchant bank, that company may receive additional fees from you related to those separate services.

What payment methods do payment processors accept?

Payment processors generally accept all types of payment except for cash or check. This includes any form of digital payment such as debit or credit card payments. Some payment processors also take electronic checks (echecks) and ACH payments, but not all. Many that do offer the service do so at an additional cost.

Payment gateways also accept credit cards and debit cards, either by swiping or by using a digital wallet. Common digital wallet payment methods are Google Pay and Apple Pay, though some retailers have their own digital wallet app, like Walmart Pay. These all link back to the customer’s debit or credit card, so often it’s just the payment authorization that’s different.

How much do payment processing services cost?

Payment processors have different fee and pricing structures (outlined under “How to choose a payment processor for your business”). These will determine how much the payment processor costs.

What fees are commonly associated with payment processing?

There are several fees associated with payment processing. That’s because everyone—from the issuing bank to the merchant bank to the credit card association takes a cut. And that’s not including the authorization and other fees taken out by the payment processor detailed earlier.

Credit card association fees: This is called an assessment fee, and it’s charged by any credit card association your business works with, including Visa, American Express, and MasterCard.

Issuing bank fees: The issuer bank is your customer’s bank, so it might feel a little silly that they’re taking fees from you. Nevertheless, these are called interchange fees. Interchange fees vary, depending on factors like your industry or the sale amount.

Merchant bank fees: Merchant bank fees are called percentage fees and also vary based on your industry, sale amount, etc. If your merchant bank is also your payment processor, you’ll pay them their percentage fee on top of their authorization and additional fees.

Can I accept payments without a payment processor?

You will need a payment processor to accept any non-cash payments. If your business only accepts cash, however, you’re off the hook.

How to choose a payment processor for your business

Choose a payment processing company based on these factors:

• Pricing: Fees, as well as the payment processing company’s pricing structure, can help you decide which payment processor is right for your business.
• Your current technology: Specifically your POS system.
• Customer service: If you run into issues processing your customer’s payments, good customer service can help you resolve them quickly.

Pricing

Before you select a payment processor, take a look at their pricing structure. This includes the size and number of fees involved.

Here are the most common pricing structures for payment processors:

Interchange plus: Some say interchange plus is the most transparent option. That’s because it breaks down what goes to the card-issuing bank (interchange fees) from the processor margin. Sometimes these rates are negotiable. The potential downside to interchange plus pricing is that interchange fees are highly variable, which means the amount you pay for each transaction will also vary.

Flat rate or pure percentage: With a flat rate, business owners pay a fixed percent for all transactions. All of your fees (including interchange fees, percentage fees, assessment fees, etc.) are bundled into a single rate that gets added to your payment processor’s transaction fee. For example, if your bundled rate is 3.2% of the transaction amount and your transaction fee is $.25, that would be 3.2% + $0.25 per transaction. If the sale were $100, you’d pay $3.45 in fees.

Tiered pricing: Tiered pricing is arguably the least beneficial to business owners. In this pricing structure, the payment processor separates those many highly variable interchange fees into three tiers: qualified, mid-qualified, and nonqualified. Eich tier has a different adjustable rate, making it difficult to anticipate how much you’ll pay in fees on each transaction. Remember that issuing banks can vary their fees, depending on factors like your industry or the sale amount.

Your business’s current technology

First to consider is your business’s current POS system, because replacing it can be expensive. Not all payment processors work with all POS systems, so if you already have a POS system in place, consider that first. You may find it’s worth it to swap out your current system for something else, depending on how much you like a certain processor.

Second to consider is how your payment processor works with your other business tools, including accounting tools. Some accounting tools like QuickBooks offer payment processor capabilities through their product offerings, like Quickbooks Payments.

Customer support

Great customer service is important in all aspects, but especially when it comes to your costs of doing business. It’s easy to become confused by transaction fees and all the tiny details of accepting card payments. Great customer service from your payment processor can help when your confidence is tested.