The card processor can either be a bank or a company that does nothing but provide card processing services.
The transaction information then goes to a credit card computer network. If the customer is using Visa, for example, the transaction will go to Visa’s network.
From there, the transaction information goes to the bank that actually issued the card. The bank then checks the account and verifies the customer has adequate credit to cover the purchase. The bank then sends the merchant an authorization over the network.
The sale is then complete, but the transaction is not—no money has changed hands yet. At the end of the business day, the merchant sends that day’s charges, called a batch, to the card network for processing.
Individual transactions are then sorted out and sent back to the individual cardholders’ banks. In a process called settlement, banks then debit cardholders’ accounts and make appropriate payments to the merchant’s credit card processor through the Federal Reserve Bank’s Automated Clearing House.
The card processor then credits the merchant’s bank account for the transaction amount, minus its fees for the transaction. Those fees also go toward paying transaction fees to the issuing bank and the credit card network.
Despite the use of computers, it can take a few business days before your account—the merchant account—is credited for credit card purchases.
Remember the scene in the “The Graduate” when a Los Angeles businessman takes Dustin Hoffman’s character aside and declares, “I just want to say one word to you—just one word—plastic”? Turns out that businessman’s vision of the future was dead on.
If you operate a small home decorating or design firm, plastic may be the key to future growth. Today’s consumer expects to pay in plastic, especially for home repair items.
THE BAD NEWS
Here’s the bad news. If your small business doesn’t accept plastic—credit cards, that is—you’ve probably got more dissatisfied customers than you realize.
Whether for convenience, security, loyalty awards or just plain habit, today’s consumer prefers to pay with plastic. In record numbers, they are ditching checks in favor of credit cards.
Not offering your customers the option to pay with plastic means fewer customers and fewer sales for your small business. If your competitors accept credit cards and you don’t, your customers may soon start doing business with your competitors.
BEHIND THE TREND
Here’s what’s driving the trend towards plastic:
• Credit Card Company Muscle. MasterCard and American Express are aggressively courting consumers and small businesses with corporate card programs that offer tremendous benefits like cash flow flexibility and bookkeeping support. Their goal? Eliminate cash and checks from existence.
• Skipping the Credit App. Businesses paying with plastic avoid lengthy credit approval processes. A valid credit card carries instant credibility and a credit line. No need to fill out those annoying credit applications!
• Rewards Programs. Credit card loyalty programs have become a big-time consumer addiction. Pay with a check and you get nothing. But put it on your card, and you can receive frequent flyer miles and other great rewards.
From the perspective of a small business, accepting credit cards increasingly makes as much sense as using them for purchases. True, you have to give up a transaction fee to the credit card companies so less money hits your bank account. The average fee usually runs between 2.5 percent and 5.5 percent of your sales. But the risk of getting stiffed on a receivable goes away—once the credit card transaction is authorized you know you will get your money. And you don’t have to wait 30 days to get it either!
WHAT ABOUT DEBIT CARDS? Debit cards, also called check cards, look exactly like Visa or MasterCard credit cards but function differently.
Debit cards draw money from a bank account, rather than receiving a line of credit like a credit card.
Debit card transactions are processed via different computer networks and thus usually require slightly different point-of-sale equipment. But, in contrast to credit card transactions, the money arrives in your account right away.
THE GOOD NEWS
If you’re bummed out that you’re losing customers because you don’t accept credit cards, here’s the good news. It’s easier than ever to start accepting credit card payments. The process of setting up your small business to accept card payments is neither mysterious nor costly.
• Step 1: Get Ready to Apply for Merchant Status
First, you must establish merchant status with each of the credit card companies you want to accept. American Express and Discover issue their own cards, so you need to apply for merchant status directly with them. Simply visit their Web sites for application details.
Visa and MasterCard are effectively brand names backed by an association. Their association membership consists of all the member banks that issue Visa and MasterCard credit cards. So, to start taking Visa or MasterCard, you must establish a merchant account with one of the several thousand banks that issue those cards. They are called acquiring banks.
You can do this either by going directly to the bank or by working with an independent credit card processor—a company whose only service is processing credit card transactions for small businesses like yours.
Establishing a merchant account isn’t always a slam-dunk. When you approach a bank or an independent credit card processor, their fundamental concern is that your company might go out of business before merchandise is shipped, in which case they will have to absorb the losses.
As such, they will thoroughly evaluate your product or service to determine the potential for chargebacks—credit card terminology for funds returned to customers. If they don’t deem you worthy, sorry, no merchant account for you. Alternatively, they may ask you to put down a security deposit—money in the bank that you won’t touch but they can tap into just in case your chargebacks outpace your account balance.
Given that issuers are selective in allocating merchant accounts, it’s important to approach your application as if you were applying for a loan. Be prepared to convince the bank you are a good risk. You will need to provide trade references, estimate the credit card volume you expect and what you think average transaction size will be. Bring your business plan, financial statements and any marketing materials (e.g. catalogs, Web screen captures and print advertisements). Be especially prepared to provide a reasonable estimate of how many chargebacks are likely. Satisfied customer testimonials and a demonstration that your product or service is priced at fair market value will help lessen their chargeback exposure concerns.
• Step 2: Shop Around and Compare
To be sure, all merchant accounts are not created equal. Even though they may be the best for establishing a merchant account, don’t limit your choices to the bank that you currently do business with.
Do your homework and shop around. Taking charge of this process by knowing what is expected and knowing your options will put you into position to recognize and negotiate a better deal.
If you find that nobody is offering you a merchant account, find companies that are similar to yours that accept credit cards and ask them how they do it. If they can, you can too.
When an issuer’s representative offers to set you up with a merchant account, compare the services, fees and terms they offer with those of other independent credit card processors and banks. Evaluate the hardware or software they provide—does it work for your business?
Always ask: Is this the best deal you can give me? Is there anything I can do to get a lower rate? You’d be surprised how willing some issuers are to negotiate.
In some cases, great terms are too good to be true. The Internet is littered with “Accept Credit Cards!” offers from questionable firms, so ask other small businesses and your accountant for referrals.
HOW TO EVALUATE PROCESSING FEESWhen evaluating whom to work with to set up your merchant account, you want to examine rates, fees and equipment costs.
• Transaction rate: Each transaction costs a little bit of money to process. But the merchant discount rate—the percentage taken from each transaction—can vary markedly.
The bank or processor will base this rate primarily on projected card sales volume (high sales = lower rate) and their calculation of the risk you pose for chargebacks. Make the case that you deserve a lower rate.
• Other fees: These details can be devils. Banks and processors often load their agreement with fees that seem insignificant when you are deal-shopping, but may prove painful later. There may be chargeback fees of $50 per returned transaction, start-up fees up to $200, per transaction communications costs of 10 to 20 cents, batch fees up to $10 per month, a postage fee for sending statements, a voice authorization fee and even a supply fee for charge slips.
Also, don’t forget that your telephone company may charge you to set up a phone link for the authorization and processing equipment. Be ready.
• Equipment costs: The equipment necessary to accept credit and debit cards varies in complexity and price, and small business owners must decide whether to lease or buy. Equipment can range from the most basic array of a telephone and a $30 printer, up to state-of-art, point-of-sale equipment that provides instant authorization.
Generally, most firms buy point-of-sale card swiping equipment that provides instant authorization and costs up to $1,500. Leasing that equipment is costlier in the long term, but allows the company to better evaluate whether it meets their needs and also upgrade as the technology improves.
• Step 3: Don’t Forget Your Backend Accounting System
A very important aspect to consider is whether the transaction equipment or software you will use to accept credit cards will integrate with your company’s computer system and accounting procedures.
Most card acceptance equipment is easily linked with small business accounting software. In some cases, software vendors will even set you up with a merchant account, usually via a third-party relationship they have in place.
For example, small business management software vendor MYOB offers a Merchant Account Service that makes it easy to process credit card sales directly from your MYOB software. Credit card transaction settlements are automatically and accurately reflected in daily cash flow and invoicing procedures. Peachtree and Intuit’s Quickbooks—two other desktop accounting software vendors—offer similar services.
Avoid a scenario in which you start accepting credit cards and then have to manually key in your credit card sales into your accounting system. That’s a recipe for disaster.
• Step 4: Start Accepting Credit Cards
Once you’ve established your merchant accounts and wired up the equipment and/or software that you’ll use to process credit cards, you’re ready to let your customers know. Inform them by putting credit card logos on your front door, your invoices and your Web site. You can get those logos from the processing companies.
Before you know it, you’ll see your bank account start to rise as the credit card sales flow in.
The bottom line is that customers, both individuals or businesses, expect to pay by plastic. Focus on the core success of any business—giving the customer what they want—by letting them pay how they want.
Charlie Jolie is founder and president of Small Biz Advisor, a small business consultancy based in Chicago, IL. Jolie has been involved in the accounting industry for more than 20 years and is an MYOB Certified Consultant (www.myob.com/us).