What is a Payment Processor? (2024)

As a business owner, it’s important to understand what’s happening when you take payments from customers. Otherwise, you could end up running into trouble when your customers encounter errors or issues. After all, every time you take a credit card payment, you’re handling sensitive financial information, so it makes sense to know as much about the process as possible. Understanding payment processing is a significant part of the equation. Find out everything you need to know about third-party payment processors with our simple guide.

What is a payment processor?

A payment processor is a company that manages the credit card transaction process, acting as a kind of mediator between the bank and the merchant. Put simply, the payment processor communicates information from your customer’s card to your bank and the customer’s bank. Assuming there are enough funds, the transaction goes through.

There are a broad range of fees associated with payment processors, including start-up fees, transaction fees, chargeback fees, termination fees, and lease charges for credit card processing equipment (generally, the third-party payment processor provides the equipment you use to accept card payments, including the credit card machines). However, if you want to accept credit or debit card payments from your customers, there’s really no other option.

Bear in mind that “payment processor” isn’t a universal legal term, and in some cases, it’s used interchangeably with terms like “payment service provider” or “acquirer”.

Payment gateway vs. payment processor vs. merchant accounts

Of course, payment processors aren’t the only significant part of the payments process. You also need to understand the role of payment gateways and merchant accounts.

So, what’s a payment gateway? Essentially, payment gateways are like middlemen between the third-party payment processor/merchant account and the credit card companies. It’s a type of software that handles the technical side of transferring cardholder information. If you don’t have a payment gateway, then you won’t be able to receive payment from your customers, even if all the other elements are in place.

And as for merchant accounts? Put simply, a merchant account is a type of bank account that accepts credit and debit card payments. If you don’t have a merchant account, you won’t be able to accept these types of payment, so it’s incredibly important that set one up when starting your business and creating a business bank account.

As you can see, it’s not really a case of payment gateway vs. payment processor vs. merchant accounts. To successfully manage the payments process, all these elements need to be included. The payment gateway handles the transfer process, the payment processor authenticates and secures the transaction, and the merchant account is where the bank settles the funds, before they’re paid into your business account.

How does the payments process work?

The payments ecosystem is confusing, with many different terms and nomenclature to get used to. But the whole thing is relatively simple. If you’re still not totally sure what happens when your customers pay using credit or debit cards, here’s a simple step by step guide:

1. The customer completes the checkout process and chooses to pay by credit or debit card, submitting their cardholder details.

2. Then, the merchant transfers the financial information, including the cardholder details, to the payment gateway.

3. After receiving the transaction details, the payment gateway transfers the information to the third-party payment processor used by the merchant.

4. Next, the payment processor will transfer the transaction information to the card network (i.e. Visa or MasterCard).

5. The card network will transfer the transaction information to the customer’s bank, which checks whether there are enough funds in the account to complete the transaction.

6. A response is then submitted to the card network, detailing whether the transaction has been approved or declined.

7. The response is then relayed by the card network to the payment processor. The payment processor relays the response to the payment gateway, informing the merchant and the customer of the response.

8. Finally, the funds are deposited by the customer’s bank into your merchant account, where they will sit for an agreed period before they are paid into your business bank account.

How to choose a payment processor

Third-party payment processors are clearly important for any business that wants to take credit or debit card payments from their customers. Want to know how to choose a payment processor? Here are some of the key elements you should look out for:

• Compatibility – Ideally, you should use a payment processor that is compatible with the other e-commerce software you’re already using.

• PCI compliance – Because you’re storing cardholder information, it’s important that your system is secure. Try to find a PCI-compliant payment processor.

• Fraud – When it comes to accepting payments, fraud is a major concern. Opt for a payment processor that has fraud prevention baked in.

We can help

GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.