How Does Payment Processing Work? 6 Retail Basics

Every time a customer swipes a credit card or taps their mobile phone to pay for goods, the payment information goes through a payment processor. 

Payment processing is an unavoidable part of modern retail, but many small business owners aren’t entirely sure what it actually entails. 

So, if you find that you’re quietly asking yourself, “How does payment processing work?” — don’t worry, you’re not alone. 

In this article, we’ll explain everything you need to know about retail payment processing, including:

• What retail payment payment processing is
• How payment processing works
• Why your choice of payment processor matters
• Tips on streamlining your payments

Payment processing is a complicated topic — but understanding the basics can go a long way in helping you improve the customer experience and your bottom line.

What Is Retail Payment Processing?

Payment processing refers to the methods and tools used by merchants and banks to securely transfer money between a customer and a business. Payment processing is used primarily for credit and debit cards, as well as contactless payment methods like digital wallets and payment apps.

Many modern point of sale (POS) systems have an integrated payment processor, meaning they have a preferred payment processor that connects directly to their system. Some POS systems also process payments in-house (more on why this matters below).  

If a payment processor is non-integrated, it will process payments independently of your POS system. This means you need to update and reconcile transactions in your POS system regularly.

How Does Payment Processing Work?

When a customer pays for items in-store or on your website, the payment goes through the following steps:

1. Payment is initiated: Customers use their credit card or other payment method at a POS system or online.
2. Payment info goes to a payment gateway: A payment gateway acts as a secure bridge between the payment processor, the customer, and the merchant.
3. Transaction is authorized: The payment processor validates the payment information and forwards it to the acquiring bank. 
4. Verification from issuing bank: At this point, the payment processor verifies the transaction details and requests the funds from the customer’s issuing bank. If the bank approves the transaction, it proceeds to the next step.
5. Transaction is completed: At this point, the funds have been transferred and all that the customer needs to do is sign or get a receipt.
6. Financial reconciliation:  All approved transactions (along with any payment processing fees) are entered into your sales records and reconciled with all of the various financial institutions. 

These steps happen in a matter of seconds, making modern payment processing sophisticated, convenient, and secure.

Why Your Choice of Payment Processor Matters

The function of a payment processor is fairly straightforward, and since any modern POS system must use some form of payment processing, it’s easy to put it out of sight and out of mind.

However, ignoring how your payments are processed can have a significant impact on the customer experience and your bottom line. Here are a few ways that different payment processors can impact your business:

• Cash flow: Payment processors will hold transactions for a certain amount of time before releasing them to you. This can seriously impact your cash flow, especially if your business is considered high-risk.
• Customer experience: There are many ways that different payment processors can affect the customer experience, from the speed of transactions to what methods they can use to pay.
• Security & chargebacks: While any payment processor must follow PCI-DSS guidelines, different providers will have different protections in place for fraud, chargebacks, and security breaches.
• Integrations: A standalone payment processor may not connect directly to your point of sale, meaning you will have to reconcile transaction data after the fact. This can be error-prone and time-consuming.
• Processing fees: Different payment processors offer different fees, which can range from flat transaction fees to varying rates per payment type. Transaction fees are major operating costs for modern retailers and can have long-term effects on your profitability. 

Mulling over the details of exactly how a customers’ payments are being processed isn’t anyone’s favorite pastime — but understanding your payment processor’s key features can cut costs and save you from added stress in the long run.

6 Basics for Smooth Retail Payment Processing

Payment processing is a confusing topic, feeling more like a high-tech, logistical problem than something that affects the day-to-day operations of your store. However, choosing the right payment processor has tangible benefits for both your business and your customers.

Here are six basic functions and best practices for modern supermarket payment processing to improve the customer experience at your store.

1. Support Multiple Payment Options

The world is increasingly digital — that includes in-person retail. People have stronger preferences about what payment methods they use, and a business that can’t keep up might be seen as old-fashioned. 

Make sure your POS system supports all of the most popular payment methods including:

• Debit and credit cards
• Tap to pay credit cards/contactless credit cards
• Mobile payment apps (Cash App, Venmo)
• Digital wallets (Apple Pay, Google Pay, Samsung Pay, etc.) 

A modern POS system should allow you to offer flexible payment methods without adding complexity to your back office or reconciliation processes. 

Ultimately, when payment is more convenient for customers, it speeds up the checkout process and leaves a positive impression.

2. Leverage Integrated, In-House Payment Processing

When choosing a payment processing partner, we always recommend using one that’s integrated directly with your POS system. This eliminates the need to manually reconcile transactions at the end of the day, which is both time-consuming and error-prone. 

Ideally, use a POS system that offers in-house payment processing. POS providers that handle payments in-house tend to offer more competitive rates for their customers and are easier to access in the event something goes wrong. 

The average payment processing fees are between 1.5-3.5%, which may seem small but add up over time. Credit cards and contactless payments will make up the bulk of your transactions, so make sure you get the best fees possible to improve your profit margins.

3. Implement Security Best Practices

While all payment processors have to follow minimum standards of data security, it’s up to individual companies to provide added security support. Make sure you understand how your payment processor handles things like:

• Credit card chargebacks
• Cases of fraud
• Data breaches

There are also steps you can take in-store to reduce the risk of fraud.

Some forms of modern payment don’t require a signature or PIN, which can increase your risk of chargebacks or fraud. Require some form of authentication for all payments, or payments above a certain threshold, to lower your risk. 

4. Have Clear Refund and Return Policies To Avoid Chargebacks

Credit card chargebacks are surprisingly common and cost businesses a lot of money. Even when a disputed charge is proven false, the funds that are held while the investigation is taking place can hurt your cash flow.

The unfortunate reality is when a business’ return or refund policies are confusing or inconvenient, a customer is likely to dispute the charge instead of jumping through those hoops. Luckily, there are several things you can do to stop this from happening. 

First, set up a clear and simple return policy. Print the return policy on your receipts and if you have a website, make sure it’s included in an FAQ or on its own page. 

With a simple return policy in place, train your employees so they know exactly what is and isn’t covered, and what to do when a customer requests a refund. Many common retail scams involve fake refunds, but having an established policy in place will help reduce your risk. 

Last, customize your POS system interface so that common refund functions are easily accessible. This will ensure that processes are easy to follow while also making the legitimate refund process easier for customers.

5. Ensure Your Payments Process When Offline

Unfortunately, with credit cards and contactless payments being the norm, businesses need to be constantly connected. So, what happens if your network goes offline? With the wrong payment processor, your business will grind to a halt.

Work with a payment processor that operates offline. Many cloud-based payment processors allow you to process and store transaction data offline, and then validate the payments once you reconnect.  

6. Offer Dual-Pricing for Cash and Debit Purchases

Transaction fees are a necessary but unfortunate part of the modern retail business. Most businesses build at least a small price increase into their cost of goods to account for these added fees. 

If your POS system supports dual pricing, you can pass on the cost-savings of cash or debit transactions directly to your customers. With dual pricing, you can set discounted rates that a cashier can select at checkout if a customer is paying with cash or a debit card. 

For dual pricing to be most effective, the card price should be your store’s regular price for the item — the cash price should always be a discount offered at checkout. This way customers will see the dual pricing as a bargain, instead of seeing the normal price as an added surcharge.

Improve the Customer Experience With a Convenient, In-House Payment Processor

We’ll admit that finding the perfect payment processor isn’t the magical solution to all of a store’s challenges. Exceptional customer service and a welcoming atmosphere will always be the most important things an independent retailer can do to stay competitive. 

However, the right payment processor can simplify the financial side of your business and improve your bottom line. At a minimum, take a moment to look into your current payment processor to understand their:

• Transaction fees
• Security process
• Chargeback policies
• Supported payment methods

Payment processing can be confusing and complex, but it doesn’t have to be. Modern retail POS systems like POS Nation offer seamless, in-house payment processing with extremely competitive rates. 

Contact our retail payment experts today to find out more about our merchant services.