When a customer places an order on your site, the process of moving the payment from their credit card to your merchant account begins. Basically, there are 3 steps: credit card authorization, settlement, and finally, funding.
Step 1: Authorization
Authorization is the process of confirming whether your customer’s credit card has sufficient credit to purchase goods or services from you, and also confirms whether the card is valid. You can obtain authorizations through a credit card machine, an ecommerce web site or over the phone. For our purposes, we’ll be discussing online ordering, as credit card authorization is different when it’s in-store versus online.
Authorization follows these steps. Generally, this entire process occurs within a matter of seconds:
- Your customer enters his or her credit card information in order to place an order. This includes their name, billing address and zip code, and Credit Verification Value or CVV, a 3 or 4 digit extra security code.
- When you customer places the order, this information is sent through your online credit card processor, which then forwards the request to the card payment brand such as Visa® or MasterCard®.
- From there, the payment brand sends your request to the card issuer (the card issuer is the bank that issued the card to the customer).
- The issuer will approve or decline the transaction, and this response is sent back to the payment brand, which then sends the response to your online credit card processor, which forwards the response to you, so you can complete the transaction.
- The card will either be approved, and you will receive an authorization number and the customer will receive a confirmation of the order. An approval means that the dollar amount you specified will be reserved from the cardholder’s available credit limit for future settlement.
- Or, the card will be declined, and the customer will have to verify the credit card information they entered and try again. If the customer continues to be declined and they insist that there shouldn’t be a problem, it is best to ask them to verify with their card issuer that they are indeed entering the correct credit card information into the order form.
Step 2: Settlement
The online transaction was successful, and your customer has received their order confirmation. For you, however, the transaction is still in process, since it must now be settled. Settlement is the process of managing electronic payment transactions so they can clear and be funded.
This is how settlement works:
- Your point of sale system submits a “batch” of transactions, usually at the end of the day, for settlement, to your online credit card processor.
- The online credit card processor forwards your settlement request to Visa, MasterCard or the appropriate payment brand for confirmation with the cardholder’s issuing bank.
- The payment brand receives the settlement request, and does two things:
- Issues a credit to your online credit card processor so they can reimburse you for the amount of the settled transaction. The issuer then pays your online credit card processor for the transaction.
- Issues a debit to the issuer to charge them for the settled transaction.
- The issuer then posts the transaction to your customer’s account. At the end of the billing period the issuer sends your customer his or her monthly statement.
- The cardholder receives his or her credit card statement and pays the bill (to the card issuer).
Step 3: Funding
The funding process is when your online credit card processor deposits money into your merchant bank account to compensate you for transactions processed.
Here’s a great summary of payment processing fees themselves work: Credit Card Processing Fees (overview from CardFellow).