How Does Payment Processing Work? Everything You Need to Know

Payment processing is an integral part of any business offering online transactions. It refers to the sequence of steps and systems that enable purchases – from verifying payment details to authorizing and settling funds between the customer and the merchant. Whether you are selling goods or services, payment processors make it possible for customers to complete purchases with just a click. There are many types of processors, but they all have one thing in common – they charge fees for their services. These fees can be flat or percentage-based, depending on your agreement. Still, every online transaction involves multiple steps before it’s finalized. So, how does an online transaction actually work?

This is a question that many people ask, but few know how to answer. That’s where this blog post comes in handy! We will talk about the online payment basics and how online transaction works. So, keep on reading.

Who Are the Participants in the Payment Processing System?

There are six key participants in an online payment transaction: customer, business owner, payment aggregator, acquiring bank, card networks, and issuing bank. To better understand their roles, especially the difference between banks – see acquiring bank vs issuing bank. They all play different roles with one goal – to complete a successful purchase.

The first participant is your customer who wants to make a purchase from you. Next up we have you (the business owner) and your bank that work together on processing the payment request sent by your customer’s credit card issuer or other financial institution such as PayPal. Your role is to ensure that all steps of the process go smoothly while at the same time protecting yourself and your money against fraudsters trying to set up fake transactions using stolen information like credit cards numbers, etc. Finally, there is an aggregator, which takes care of sending requests to acquirers and ensuring that transactions are completed.

This is how an online transaction works with the help of the players involved. Let’s take an in-depth look at how these entities work to make the online transaction process smoother.

What Is the Payment Process and How Does It Work?

Now that you know the entities involved in payment processing, let’s take a look at the steps involved in how a payment is processed.

In case any disputes happen regarding a particular purchase made using credit cards (such as when a product received by a consumer doesn’t match what was advertised), then banks may hold funds until all parties involved negotiate amicably about their grievances or go through legal proceedings to settle such disputes. This process is known as a chargeback, and it can potentially harm your online business credit worthiness if there are too many of these happening repeatedly with different customers.

Simply put:

1. The customer pays the merchant via credit card.
2. The merchant forwards the request to the payment aggregator.
3. The payment aggregator sends an authorisation request to the card issuer.
4. If the transaction is approved by the issuing bank, the customer’s card is debited and the money is transferred to the acquiring bank.

What Are Chargebacks in the Payment Process?

A chargeback occurs when a cardholder disputes a transaction that appears on their statement – for example, due to a defective product, an unrecognized charge, or non-delivery of goods. When this happens, the issuing bank initiates an investigation by contacting the merchant and requesting details about how the transaction was processed and authorized.

If the chargeback is resolved in favor of the cardholder, the transaction amount is refunded from the merchant’s account. Additionally, most payment providers impose a chargeback fee, which can accumulate quickly if disputes occur frequently. High chargeback ratios may also impact your credibility as a merchant and lead to higher processing costs or even account termination.

Understanding the Payment Processing Procedure: Conclusion

Understanding how payment processing works – from the roles of key participants to the steps of authorization and settlement – is essential for any online business. By choosing reliable partners and monitoring each stage, you can improve conversion rates and reduce the risk of fraud. For a deeper understanding of the technical terms used in payment processing, check out our complete payment terminology glossary.