What is a payment processor? How to pick the right system

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Businesses need a reliable way to accept customer payments, whether online or in person. Ensuring payments are processed quickly and securely is vital, not only for your business but also for your customers.

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If you accept credit cards or other electronic payments, you'll need a third-party payment processor to handle those transactions and ensure the safe transfer of funds. In this article, we'll explain what payment processors are, how they work, and how to choose the right processor for your business.

What is a payment processor?

A payment processor is a service that facilitates electronic payments between merchants and their customers. It securely routes payment information between the merchant’s account (the acquiring bank), the customer’s account (the issuing bank), and card networks like Visa, MasterCard, and American Express.

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Payment processors handle all types of electronic transactions, including credit and debit card purchases, Automated Clearing House (ACH) transfers, and digital wallet payments. With the right payment processor, you should never have to worry about the security or reliability of your transactions.

What do payment processors do?

A payment processor’s main role is to ensure that electronic payments are processed quickly, securely, and reliably. To that end, here are the key functions payment processors perform:

• Transaction processing: When a customer makes a payment, your payment processor receives the transaction information from your customer’s credit card or bank account and securely transfers this payment data to your business account, ensuring timely receipt of funds and improving cash flow management
• Authentication and authorization: Payment processors validate the customer’s identity and payment information and ensure they have sufficient funds to make the purchase
• Data security and encryption: Payment processors encrypt sensitive financial information for both you and your customers, ensuring compliance with data security regulations like PCI DSS (Payment Card Industry Data Security Standard)
• Fraud detection and dispute resolution: Payment processing services help minimize the risk of fraud by flagging unusual or high-risk transactions. They also assist in managing chargebacks and disputes, reducing the administrative burden on your team
• Subscriptions and recurring payments: Payment processors help automate billing processes for businesses with recurring revenue models like SaaS companies and other subscription-based services
• Reporting and analytics: You can use the transaction data from your payment processor to build reports and analyze trends, helping you make better decisions on everything from marketing and inventory to strategic budgeting
• Handling multiple payment methods and currencies: The best payment processors can handle multiple B2C and B2B payment methods, including card, ACH, wire transfer, and digital wallets, across a variety of global currencies

What are some examples of payment processors?

Popular payment processors include PayPal, Square, and Stripe, among many others:

• PayPal: One of the oldest and most well-recognized online payment systems, PayPal can be used for both business and peer-to-peer (P2P) transactions
• Square: Square is one of the largest point-of-sale (POS) systems in the US, enabling businesses to accept credit and debit card payments both in-store and online
• Stripe: Some of the world’s largest companies use Stripe as their payment solution, and it’s especially well-suited for recurring revenue models like SaaS
• Helcim: Helcim is a payment processing company that’s popular with small and medium-sized businesses thanks to its straightforward pricing model
• WorldPay: Geared toward global businesses with international payment needs, WorldPay supports transactions across 146 countries and 135 currencies
• Fiserv: Fiserv is a major fintech company that offers payment processing services for the financial services industry, including banks, credit unions, and mortgage lenders
• Amazon Pay: Amazon’s payment processing solution lets customers buy from your site using their Amazon account

How do payment processors work?

To understand how payment processors work, here are the main steps involved in completing a transaction:

1. A customer initiates a transaction: The payment process starts when a customer makes a purchase with an electronic payment method, either through a payment gateway on your website, at a POS terminal in your physical store, or via mobile app
2. The payment processor receives the payment information: Your POS system or online checkout encrypts the customer’s payment information and transmits it to your payment processor
3. The payment processor requests authorization: Your payment processor then sends the transaction details to your customer’s account or card issuer to verify that the transaction is legitimate and that they have sufficient funds to cover the purchase
4. The transaction is authorized: Your customer’s bank, card issuer, or other account either approves or declines the transaction and sends the response back to your payment processor
5. The payment is settled: If the transaction is approved, your payment processor initiates an electronic funds transfer (EFT) from your customer’s account to your merchant account, finalizing the sale

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Thanks to the power of modern software and efficient compute, payment processors work quickly and reliably. Depending on the method of payment used and the particular payment processor, payments can go through immediately or may take a few business days.

Understanding payment processing fees

Payment processing fees are the expenses your business incurs to process credit card payments. All payment processors charge fees to cover the costs of processing payments, though their pricing models may differ.

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Here are the three main components that determine the total transaction fee:

1. Interchange fees account for the majority of the total fees. The various card networks set these credit card processing fees, and they ultimately go to the financial institution that issued the customer’s card. Interchange fees are usually a percentage of the transaction amount plus a fixed fee (e.g., 1.5% of the total transaction + $0.10).
2. Assessment fees are charged by card networks to cover the use of their payment infrastructure. These fees go directly to the card companies, and they’re typically a smaller percentage of the transaction amount (e.g., 0.14% for Visa and 0.17% for Amex).
3. Payment processor fees compensate your payment processor for their role in facilitating the transaction. Depending on your payment processing partner, it could be a percentage of the transaction, a fixed fee, or a combination of both.

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As you’re researching payment processors for your business, the pricing model they use will be one of the most important factors to consider—more on that below.

How to choose a payment processor for your business

Here are the major factors business owners and entrepreneurs should consider when choosing a payment processor:

Pricing model

Choose a payment processor whose fee structure aligns with your business needs. Most payment processors use one of two pricing models:

1. Flat-rate pricing: A single fixed rate for all transactions. It usually consists of a fixed percentage and, often, a fixed fee. For example, Stripe charges 2.9% + $0.30 per card transaction for domestic payments. While these fees are simple and predictable, they may wind up being more expensive for businesses with a high sales volume.
2. Interchange-plus pricing: The actual interchange and assessment fees for each transaction plus a fixed fee from the payment processor. This model can often be less expensive than flat-rate pricing and offers greater transparency into the fees involved, but you’ll experience higher variability due to the sheer number of interchange rates.

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If you have a high volume of transactions, a large average sale price, or both, then an interchange-plus pricing model might be the better choice for your business. If you have a low sales volume and value the predictability of a fixed rate, choose a payment processor with a flat-rate model.

Payment methods accepted

Offering multiple payment options at checkout can improve the customer experience. Make sure the payment processor you choose supports your customers' preferred payment methods, including credit and debit cards, digital wallets, or online payment platforms. B2B companies will also want to prioritize processors that can handle ACH payments and wire transfers as well.

Where and how you do business

If your business has a global customer base or you plan to expand internationally, look for a payment processor that can handle multiple currencies. Be sure to look into currency conversion fees and other charges for international transactions as well.

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Similarly, if you handle a lot of in-person transactions in brick-and-mortar locations, you might want to prioritize a payment processor that offers its own POS hardware. This kind of integrated system can eliminate any potential integration problems with your existing hardware.

Integration and compatibility

If you’re happy with your existing e-commerce platform, POS system, accounting software, and other business tooling, choose a payment processor that offers extensive integration capabilities. Most modern payment processors provide plugins or APIs to connect all your systems, allowing for the seamless transfer of financial information.

Scalability

Consider whether the payment processor will be able to grow with your business. It must be able to handle an increased transaction volume as you scale, and it should also offer more advanced features like subscription billing, recurring payments, invoicing, and detailed analytics.

Customer support

Look for a payment processor that offers 24/7 customer support through multiple channels, such as phone, email, or live chat. Responsive and accessible customer support ensures you can resolve issues quickly, minimizing any potential disruptions to your business. Seek out user reviews or peer recommendations to get a sense of the processor’s customer service.

Contract terms

Review the payment processor’s contract terms, keeping an eye out for any termination fees or minimum requirements. Some processors require long-term contracts, while others offer month-to-month agreements or even no-contract relationships. Look for a payment processor with transparent terms that meet your current and future business needs.

How the right payment processor helps improve cash flow

Understanding what payment processors do and how they charge for service will better equip you to choose the best partner for your business. With the right payment processor, you can be sure your sales revenue will land in your business accounts quickly and reliably, helping you maintain a healthy cash flow to cover your business expenses.

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That’s where Ramp’s finance operations platform can help. Ramp streamlines your vendor payment workflow so every bill is recorded, approved, and paid without any manual entry. With Ramp, you can consolidate all your payment methods into a single platform—pay domestic and global vendors by card, check, same-day ACH, or international wire.

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Ready to learn more? See how Ramp Bill Pay can save you time and money.