How Does a Credit Card Transaction Get Processed?

It all begins when a Cardholder, your customer, presents their credit card to you to pay for the goods or services you are selling. In a retail or “card present” environment, the customer hands you their credit card. In an e-Commerce environment or “card-not-present” environment, the customer presents their credit card to you on the secure checkout page of your online shopping cart. There are 7 steps in the life of a transaction.

Authorization

The first step is called the Authorization which is the process of requesting an authorization from the bank or company that issued the customer’s credit card. For Internet Merchants, the shopping cart is connected to or integrated with a Payment Gateway. For Retail Merchants, the card is swiped through a magnetic reader on the Point of Sale (POS) Terminal. The Payment Gateway and POS Terminal then connects to a Front-End Processor. If the credit card used is a Visa or Mastercard (V/MC), the Front-End Processor transmits the authorization to the Visa or Mastercard Associations who then rout it to the appropriate Issuing Bank. Otherwise, the authorization is transmitted to the appropriate Card Issuer (Amex, Discover, Diners, JCB) for approval. The Issuing Bank or Card Issuer authenticates the Cardholder and approves or declines the transaction amount.

It is important to note that no money changes hands during the Authorization. Merchants must re-present the transaction to receive payment. For Retail Merchants, the transaction is stored on the POS Terminal. For Internet Merchants the transaction is stored on the Payment Gateway.

Merchant Balancing

The second step is called Merchant Balancing which is the process of totaling the transactions and balances by card type and transmitting them to the Front-End Processor. This is also known as Batching Out. Most POS Terminals and all Payment Gateways perform an auto close function at the end of the day and batch out automatically.

Capture

The third step is called the Capture which is the process of requesting payment from the Issuing Bank or Card Issuer. The Front-End Processor matches the Authorization data to the settlement data and transmits the card capture file to a Back-End Processor for V/MC transactions or to the appropriate Card Issuer for other card types.

Clearing

The fourth step is called Clearing. During this stage the Back-End Processor performs compliance checks and risk management procedures and transmits the transaction to V/MC or to the appropriate Card Issuer for other card types.

Interchange (VS/MC Only)

The fifth step is called Interchange. During this stage the V/MC Associations sort the transactions by Issuing Bank and transmit them to the appropriate Issuing Banks for settlement.

Settlement

The sixth step is called Settlement. During this stage the Issuing Bank calculates fees and deductions (i.e., chargebacks) and routs the net funds to the V/MC Associations who then sort them by Acquiring Bank and transmit them to the appropriate Acquiring Bank for payment to the merchant. For other card types, the appropriate Card Issuer determines the daily deposit for the merchant.

Merchant ACH

The final step is the Merchant ACH. During this stage the Acquiring Bank or Card Issuer transmits the merchant deposit to the merchant’s checking account.

The typical timeline for the transaction processing is as follows:

Day 1: Authorization
Day 2: Merchant Balancing/Capture/Clearing/Interchange/Settlement
Day 3: Merchant ACH