Payment Processing Explained: How It Works and What It Costs
To a customer, paying at checkout seems simple: swipe a card, and the money goes straight to the business. In reality, security checks, compliance requirements, and fees mean multiple banks, networks, and financial systems have to communicate to move those funds safely. That process is called payment processing.
The steps are largely the same everywhere, but the provider you choose affects your fees, how easy setup is, and what your customers see at checkout. Understanding how it all works makes it easier to pick the right one.
In this guide, we'll cover how payment processing works, the systems involved, how processors charge for their services, and what to evaluate when building a payment stack. We'll also look at Slash, a financial platform that supports payment processing in the same place as its other business banking tools.¹ Slash allows businesses to both accept card payments for invoices and build a custom checkout experience with an SDK (software development kit).
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Glossary
We’ll be using quite a few technical terms throughout this guide that might be confusing to someone who’s new to the world of digital payments. Before we start, take a look at this glossary of important terms:
- Payment gateway: Thetechnology that captures and transfers payment data from a customer to a processor. It sits at the beginning of the overall process.
- Payment processor: The financial service that manages the backend logistics of electronic transactions. Common examples include Stripe, PayPal Open, and Square.
- Payment service provider: A standalone product that bundles payment gateways, payment processors, and other merchant services together.
- PCI DSS: Stands for Payment Card Industry Data Security Standard, which is the set of security standards that govern how payment data must be handled.
- Card networks: The infrastructures that power debit and credit card transactions. Common examples include Mastercard, Visa, and Discover.
- Issuing bank: The customer's bank in a given transaction. It’s the financial institution that issued the card being used for the purchase.
- Acquiring bank: The merchant’s bank in a given transaction. It receives the funds from a purchase.
- Merchant account: A specialized holding account specifically designed for processing transactions from cards or digital wallets.
What Is Payment Processing?
Payment processing is the term that describes the steps and systems involved in authorizing, routing, and settling a transaction from the moment the customer pays to the moment funds reach a business's account. Unlike some simpler transfers, it’s not a quick trip from point A to point B. It's a chain that connects a customer's bank account to a merchant's account through a few other parties.
The term covers a wide range of payment types. It can apply to credit card and debit card transactions, online checkout payments, bank transfers, digital wallets like Apple Pay or Google Pay, and ACH transfers. The specific systems involved might vary depending on the payment method, but they’ll always check the same boxes. They validate that a payment is legitimate, send the authorization request, and eventually move funds to the merchant account.
How Processing Payments Works Behind the Scenes
Before a business can access the funds from a purchase, the transaction needs to be approved, routed, recorded, and settled. Let’s break these steps down in a little more detail:
Authorization
Before anything else, the purchase has to be authorized. When a customer initiates a payment, the payment details are captured and transmitted securely to the payment processor. The processor validates the information and routes an authorization request through the card network to the customer's issuing bank. The bank checks for available funds or credit, evaluates fraud signals, and returns an approval or decline almost instantly.
An approved authorization doesn't mean money has moved yet. Instead, it’s more like a hold. The issuer sets aside the funds and communicates to the payment processing system that the payment is valid. The funds don’t actually travel until later down the line.
Clearing
After authorization, the transaction enters the clearing stage. Here, the details of the approved transaction are exchanged between the acquiring bank and the issuing bank through the card network. Clearing confirms the transaction record and calculates exactly what's owed by whom, including the fees owed to the card network and issuing bank, which are deducted before funds reach the merchant.
When it comes to credit or debit card transactions, clearing often happens in batches. Merchants can submit a batch of approved transactions at the end of each business day, and the clearing process runs across all of them together.
Settlement
Settlement is when funds actually transfer through the banking and payment networks and become available to the business. The issuing bank sends the funds through the card network to the acquiring bank, which deposits them into the merchant's account after deducting processing fees.
The actual timing of settlement varies. Depending on the payment method, processor, and fraud checks, funds may become available on the same day or several business days after the transaction was approved. Business owners that want a consistent cash flow should confirm settlement timelines with their processor before going live, since long payout delays can affect financial analysis and reporting.
The Systems Involved in Processing Payments
In order to construct an efficient payment processing system for your business, it’s important to know what task belongs to who. Let’s take a closer look at each party involved in moving a transaction from place to place:
Payment Gateway
The payment gateway securely captures, encrypts, and sends payment information between the customer, merchant, processor, and payment networks during checkout. In short, when a customer enters their credit card details at checkout, this system handles that information and sends it onward. With Slash, you can use an SDK and Payment Elements to build a custom payment gateway within your existing checkout.
The gateway is the infrastructure behind the checkout page, but it’s not technically the page itself. The form a customer fills out does link to the gateway, but the data only reaches that gateway when the customer hits submit and leaves the checkout page.
Payment Processor
The payment processor is the system that routes the transaction between the merchant's acquiring bank and the customer's issuing bank, communicating through the card network. It’s in charge of managing the authorization request and coordinating the clearing and settlement that follow. When a client pays a Slash user’s invoice with a card, the payment processor handles it.
Some merchants work with a processor separately from their gateway, such as Stripe or Square. Others use a full payment service provider that bundles both functions together. Each option ultimately gets the job done, but they can come with different fees and implementation timelines.
Issuing and Acquiring Banks
Two banks are involved in every card transaction. The issuing bank is responsible for approving or declining the transaction and for releasing funds during settlement. Afterwards, the acquiring bank receives the payment on behalf of the merchant, processes the transaction, and deposits funds into the merchant account after settlement clears. Some payment service providers handle the steps that the acquiring bank would usually take.
Card Networks
Card networks like Visa and Mastercard send authorization requests between banks during a transaction. They also set the interchange rates, which are the fees that acquiring banks pay to issuing banks. Not only does the customer’s card network affect interchange costs for a merchant, but their actual card can as well. To offset their perks and rewards, many premium credit cards come with higher fees that the business is responsible for paying.
Merchant Account
A merchant account is the bank account that holds funds before they’re transferred to a business's operating account after settlement. Typically, merchants open a standalone merchant account with a financial institution.
However, some payment service providers bundle the merchant account function into their platform, meaning businesses can accept card payments without opening a separate bank account. Slash Payment Processing, for instance, is a managed merchant of record (MoR) solution, meaning you don't have to hold a separate merchant account or apply for a merchant ID number.
How Payment Processors Charge Businesses
Once you start accepting purchases at your storefront, you can expect fees from the card networks, the issuing bank, and the payment processor. While it might seem like a lot at first, you can take certain strategies to minimize those charges. Here’s an overview of each fee you may run into:
Card Network and Processor Fees
As you begin accepting card payments, there are three fees you’ll consistently pay:
- Interchange fees are set by the card networks and paid to the issuing bank. Representing the largest portion of most processing costs, they can vary by card type, transaction method, and risk.
- Assessment fees are a small percentage (0.1%-0.2%) charged by the card networks themselves to fund their infrastructure.
- Processor fees are the markup your payment processor adds on top of those two fixed costs. These fees can potentially be negotiated, especially if your business carries high traffic that’s valuable to your provider.
Different Types of Pricing
Depending on your processor, you may arrange for different pricing formats. Flat-rate pricing charges a single fixed percentage for every card transaction. Whether a customer swipes a fancy rewards credit card or a basic debit card, you’ll pay the same rate.
Interchange-plus pricing adds a defined processor markup at the end of each transaction after the interchange and network fees. This structure allows a bit more visibility into the cost breakdown, and can result in lower overall fees for businesses with higher volumes or a favorable card mix.
You may also take advantage of tiered pricing groups, which label transactions as qualified, mid-qualified, or non-qualified based on the transaction's risk and card characteristics. Each tier gets a different rate. This may not be as handy as you initially think, since merchants usually don’t know which tier a given transaction will fall into until it's already been processed.
Situational Fees
Beyond these pricing models, businesses can also run into quite a few extra charges, depending on their setup. These can include monthly platform fees, chargeback fees, currency conversion fees, POS (point of sale) system costs for in-person setups, account termination fees, fraud prevention tool costs, and any PCI DSS compliance-related charges. There’s a lot to account for, but comparing the all-in price is how you get the most accurate picture of what a payment setup will actually cost to run.
What Businesses Should Evaluate in a Payment Processing Setup
Your payment processing setup should be chosen based on how a business sells, where its customers are, and what payment methods are most often used. When evaluating your options, take the following factors into consideration for both your current operations and your future plans:
- Online vs. in-person sales: In-person card transactions typically carry lower processing fees than card-not-present transactions because the fraud risk is lower. If your business works in-person and online, confirm that the processor handles both and that you’re satisfied with the fee structure.
- Supported payment methods: Not all processors support the same payment types. Verify that the provider supports the specific methods your customers use, including digital wallets, buy-now-pay-later options, or ACH, before building your checkout experience.
- Payout timing: Some processors send funds right away, while others can take up to 2-3 business days. This isn’t a big deal for businesses with a healthy cash flow, but it may be for merchants working with tight liquidity.
- Integrations: Confirm that the processor connects cleanly with your existing tools, including your e-commerce platform and accounting software. Slash is a platform that not only comes with both payment processing and business banking features, but also integrates two-ways with platforms like QuickBooks Online and Sage Intacct.
- Fraud prevention and PCI DSS: Processors and PSPs often provide fraud detection tools, secure payment handling, and PCI-related support. That said, businesses still remain responsible for understanding their own compliance obligations based on how they collect, store, and process payment data.
- International or multicurrency needs: If you accept payments from customers in other countries, take a look at how the processor handles cross-border volume. This means evaluating which currencies are supported, what foreign exchange costs apply, and how settlement works across jurisdictions.
Master Payment Processing With Slash
As you compare payment processors' fees and features, it's easy to overlook how each one fits into your tech stack. Every separate gateway, invoicing tool, and banking app you add makes your finances harder to manage.
Slash is a business banking platform that lets qualifying users accept card payments two ways: native card acceptance in Slash Invoicing, or a custom web checkout built with our SDK. Either way, payments appear in one live dashboard where you can see each payment's fee breakdown, handle chargebacks and refunds, and track processed funds into your Slash accounts.
Our payment processor also functions as a merchant of record, meaning the legal authorization for processing transactions and maintaining regulatory compliance rests in our hands. Our per-transaction fee of 3% plus 40 cents is much lower than just about any other MoR on the market. However, business owners who use Slash are still in charge of calculating their sales tax and filing at the end of the period.
Here’s what else you get with Slash:
- Slash Visa® Platinum Card: Corporate charge card that comes with customizable spend controls and unlimited virtual cards for handling team expenses, vendor payments, subscriptions, and more. Earn up to 2% cash back on eligible business purchases.
- Accounting & ERP integrations: Sync transaction data with QuickBooks Online, Xero, NetSuite, or Sage Intacct to streamline reconciliation, reporting, and month-end close.
- Working capital financing: Access short-term financing with flexible 30-, 60-, or 90-day repayment terms to help bridge cash flow gaps.⁵
- Invoicing: With Slash’s invoicing and bill pay features, users can send customized invoices, collect payments, and manage vendor bills all in the same place.
If you're looking for a solution that has a payment processor, gateway, and a lot more, give Slash a try today.
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Key Takeaways
- Authorization is a hold rather than a transfer, since the issuing bank only sets funds aside and the money doesn’t move until settlement.
- Interchange is the largest component of processing cost, set by the card networks and paid to the issuing bank.
- With tiered pricing, merchants don't find out which tier a transaction fell into until after it's already processed, which makes it tough to plan around.
- Card-present transactions generally cost less than card-not-present ones, since the fraud risk is lower.
- The headline rate isn't the real overall cost. You should instead compare all-in pricing, including monthly platform fees, chargeback fees, currency conversion, POS hardware, termination penalties, and PCI-related charges.
Frequently Asked Questions
What's the difference between online payments using credit cards and in-person card swipes?
Online transactions (card-not-present) are more vulnerable to fraud, as stolen credit card information can be used without the merchant or processor knowing. In-person transactions (card-present) are generally safer. For that reason, payment processors often charge higher fees for online payments.
How to Accept Payments Online: Guide for Small Businesses
What's a POS (point-of-sale) system?
A POS system is the physical terminal that allows storefronts to accept different payment methods like credit cards and digital wallets.
Payment Gateway vs. Payment Processor: 5 Key Differences
What happens during a chargeback, and does the merchant get their processing fees back?
When a cardholder files a chargeback, their issuer investigates the transaction and forces a payment reversal if their claim is valid based on the context and payment details. Unfortunately, the associated fees do not return to the merchant account.
Chargeback Prevention: 6 Ways to Protect Revenue and Reduce Risk
Is there a difference between a merchant account and a general business bank account?
Yes. A merchant account is a temporary holding account specifically for processing credit and debit card transactions. A business bank account is your primary operating account used to pay expenses, deposit cash, and manage your company's overall finances.
Merchant Accounts: How Card Payments Work
