Do youaccept and process debit and credit card payments? If so,your business needsto understand how payment processing works, who is involved,andhow long it takes.This article willdiscussthe differences betweenpayment authorization and settlementto illustratethis two-stage processinvolvingmultiple parties.
Credit Card Processing
Did you know thattoday’s customers use non-cash payment methods for74 percent of transactions? A2020 Federal Reservestudyfoundthat29 percent ofalltransactions are from credit cards, a number that will continue to increase due to the convenienceand reliabilityof digital money.While you likely know how popular card payments are, you may not be familiar with howcard payments are authorized and settled.Indeed, these steps are necessaryto receive paymentfrom your customersin exchangefor the products and servicesthey purchase with adebit or credit card.
Payment Authorization
Payment authorizationis whenthe merchant submits a transaction request to the issuing bank (cardholder’s bank), who will determine if the transaction should be approved or denied.The issuing bank willdecideafter verifying that the cardholder hasthe appropriate funds or credit in their account.Afteran authorization request has been sent, the merchant will receive a responsecode from the card association. These authorizationresponsecodestypically containtwo digits (like 00)or a letter and number (N1). Indeed, there are over 50 different codes, which are different for each card association, payment processor, or gateway.While there arevariouscodes,the issuer will recommend merchants do one of two things– approve or decline the pending transaction.
Common Reasons for Denied Transactions
An issuingbank may recommend that a merchant decline a transaction for various reasons.
- The cardholder’s account lacks sufficient funds or credit to make a purchase.
- The cardholder reports that their card is lost or stolen, thereforeit’s a fraudulent transaction.
- Keycardholderdetails were not entered correctly orat all, such assecurity codes.
- Thepayment processing technology is malfunctioning, so the issuing bankcannotsend an accurate, timelyresponse.
While these are just a few scenarios, thecriticalpoint is that merchants shouldonly settle transactions that have received an approved response code.If merchants receive any other code, it’s a good idea to decline thetransaction and request the customer to use a different form of payment, such as cash, check, ora different card. It is possible tore-authorize the same card within 12 hours of the first attempt, makingthe transaction eligible for a declined authorization chargeback.
Approved Transactions
For a transaction to be approved, tworequirementsneed tobe fulfilled.The cardholder’s account must have enough money or available credit to pay for the products or services.The card also must not be reported as lost or stolen, which would indicatecardfraud.
Settlement
Once a transaction has been approved,settlement is the second and final step.Thisis whenthe issuing banktransfers thefunds from the cardholder’s accountto the payment processor, who then transfers the moneyto the acquiringbank. Thebusiness will then receive theauthorizedfunds initsmerchant account.The amount of time it takes to complete the settlementprocess will vary based on theissuing bankand type of transaction.Someauthorizedtransactions may get settled immediately, while others could take hours, days, or even weeks tosettle.
Examples of Settlement Strategies Used byMerchants
- A grocery or department storewillsettle authorized transactions immediatelybecause customers leavewith the purchased goods.
- A hotel may authorize transactions whena customer books areservation butwill not settle the transaction until a week after the guest checks out. This isa good idea since reservations may be canceled or updated fordifferent dates or rooms.
- A restaurantlikely authorizes a transaction when the customer paystheir bill but will wait until after the tip is given to settle it,whichwill alter the total price.
- A virtual storewill authorizea transaction during the checkout process. However, the transactionisusuallynotsettled until the next business day whenthe products areconfirmedandshipped to the customer.
Furthermore, merchants should be awarethat authorization response codes provide a real-timeupdate of a cardholder’s account status.While a cardholder may have enough money in their account now, it does not guarantee that the appropriate funds or credit will be availableata different hour, day, or week. Keep this in mind if your businesspostpones the settlement process.Unless you use an authorization hold, this could lead to not receiving payment from your customers.
Authorization Holds
If your business needs to delay the settlement process, it may be a good idea toadd authorization holds into your payment process.Let’s take a look at how this works below.
- The customer places an order using their debit or credit card.
- Once the issuing bank authorizes the transaction, you can place an authorization hold onthe transaction.
- Thiswill hold the authorized transaction amount inthecardholder’s account, thus preventing them from spending those fundsonsomething else.
- Indeed, this will guarantee thatthe money or credit will be there when you settle the pending transaction.
Secure Cardholder Data with Payment Tokenization
We hope this article helped illustratethe differences betweenpayment authorization and settlement, the two-stageprocesses involved in credit card processing. Aside from knowing how this process works, it’s alsoessentialtosecure cardholder data to prevent payment fraud,chargeback fees, loss of profits, goods or services, andbrand reputation.Today’s customers expect businesses to do everything in their power to protect and secure theirpayment details. Ifyou don’t, they will probably take their business elsewhere.Learn more about our payment tokenizationatTokenEx, so your business can enjoy improved payment security and fewer false declines and chargebacks without sacrificing critical business operations.
