Small business guide: What is credit card processing?

In this article:

• What is credit card processing?
• Steps and parties involved with credit card processing
• How can credit card processing help your business?

Most businesses are familiar with the concept of credit card processing. It allows customers to purchase items or services with their credit or debit cards in person and online. But what you might not know is that this process is much more complex behind the scenes. 

Throughout this article, we’ll walk you through how credit card processing works and why it’s important for pretty much any business. 

What is credit card processing?

The basic concept of credit card processing is that a customer swipes, “dips,” or taps their card on a terminal or enters their card information online, the payment is authorized, and the transaction is complete. However, that’s only what happens on the surface. This process is much more intricate than it seems, and it can be helpful for business owners to understand how this works. 

How does credit card processing work?

So, what are the steps involved in credit card processing? It can help to understand all of the parties that are involved first. 

Of course, you have the cardholder, or customer, and the merchant (your business). Other participants include:

• The merchant’s bank: The bank that is receiving the payment from the purchase
• The processor: This is usually a POS (point of sale) service provider that is used for to process the payment. It may be a traditional payments processor, a third-party payments facilitator, or some extension of your bank that provides the ability to process credit cards
• Credit card network: The provider of the card itself, like Visa or Mastercard. They act kind of as a liaison between the payment processor and the banks involved
• Issuing bank: The customer’s bank that issued the credit card and where the payment is being pulled from

Knowing each party’s involvement in the process will help us to explain exactly how this works behind the scenes. 

There are three main steps that take place in processing a credit card transaction:

1. Authorization
2. Authentication
3. Clearing and settlement

While it seems that everything happens immediately and the payment goes through with ease at the counter or online, the entire process can take 24-48 hours. 

Let’s start with step 1: Authorization. 

This is the part the most of us are pretty familiar with. In this phase, the issuing bank as to give approval to the merchant to proceed with the transaction. 

The customer gives their card to the merchant to swipe on a terminal provided by the processor, or provides their credit card number into a field online. Then an internet connection or phone line is used to send the credit card information to the merchant’s bank. 

The merchant’s bank then passes those details along to the credit card network, and the credit card network requests authorization from the issuing bank. The authorization request includes the following information:

• Credit card number
• Expiration date
• Billing address
• CVV or security code
• Transaction amount

Step 2: Authentication

Authentication is the final step that takes place in the store or online as the transaction is completed, but it isn’t the final step of the entire process. This just allows the customer to go through with their purchase and accept their goods or service. 

In this phase, the issuing bank uses fraud protection tools like Address Verification Service (AVS) and the card’s security code to verify the credit card. 

The issuing bank gets the authorization request from the credit card network and validates the card details and checks to see if the customer has any funds available in their account. The issuing bank then approves or declines the transaction and sends this back through the credit card network, which then passes that information onto the processor or merchant bank. 

When the merchant receives approval to move forward with the transaction, a hold is placed on the purchase amount in the customer’s bank account. 

Then the customer receives their receipt and continues on their day.

These first two steps take place in a matter of seconds, but it’s good to know how much is going on behind the scenes so that is something does go wrong, you can assess the situation from a point of knowledge and understanding. 

Step 3: Clearing and settlement

The final stages of the credit card process occur at the same time and over the course of the next 24-48 hours. 

At the end of each business day, the merchant will send all approved transactions to their payment processor or bank. The processor then sends the approved transactions back to the credit card network, where the forward each approved transaction onto the issuing bank. 

This is where the customer might see a hold or “pending” amount in the bank account until the transaction is finalized. Within 24-48 hours the issuing bank will send the funds back through the credit card network and to the processor and merchant’s bank. 

Any fees that are owed to the credit card network or payment processor will come out of these funds, and the merchant will receive the remaining amount. 

Once everything goes through, the hold will be removed from the customer’s account and they’ll see their transaction information posted on their account. 

How can credit card processing help your business?

Credit card processing isn’t a new concept for small businesses. Most businesses offer some form of credit card processing, whether online, via a terminal, or even over the phone. Because it isn’t common practice to carry cash around and fewer people even have checkbooks anymore, customers expect businesses to accept credit cards. 

Having some form of credit card processing will allow your business to have more opportunities for sales, whether you’re in retail or the service industry. 

One thing that prevents some business owners from getting a credit card processor is the fees that are associated with it. These fees can vary a lot and may be a percentage of each transaction or a flat rate per transaction required by your service provider. While these can add up and be intimidating, the increased sales that you are likely to get from offering credit card transactions will more than make up for the increased cost. 

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