The complete guide to payment processing

Payment processing is the underlying system that supports financial transactions between customers and merchants. It covers the entire journey of handling and moving funds from a customer's account to a business's account after a cashless transaction is initiated online, in-person, or in an app. 

Payment processing has evolved over decades. Today, it’s a modern digital ecosystem that keeps business moving. Its core goal is simple: transfer funds securely and efficiently at scale. 

Payment processing technologies

Part of what makes payment processing so impressive is its speed. That’s only possible because of a sophisticated tech stack that balances two competing priorities: frictionless speed for the customer and impenetrable security for the business. 

As consumers, we’re all familiar with the critical touchpoints where data is captured, protected, and moved: 

• Payment gateway: A service portal that securely captures, encrypts, processes, and transmits payment data between point of sale systems and banks

• Point of Sale (POS) device: Physical devices or digital platforms where a customer initiates the payment

• Credit cards and debit cards: Physical or digital financial instruments used by customers to initiate payments

• Digital wallets: A common electronic payment method that lets customers store their payment information on a phone or smart device for card-free transactions

There is also an invisible infrastructure that ties all of these touch points together. A few of these core technologies include:

• Payment networks (card schemes): These are the global "highways" like Visa, Mastercard, and American Express. They provide the central infrastructure that sets the rules and communicates between the merchant's bank and the customer's bank.

• Acquiring host (processor): Processors connect the merchant to the payment networks. It’s responsible for the technical heavy lifting: routing the transaction to the right network and ensuring the data follows the correct protocols.

• 3D Secure (3DS): An invisible security layer that adds an extra authentication step for online store owners. It works in the background to verify the cardholder's identity without adding unnecessary friction to the checkout.

Payment processing is a sophisticated, fast, and secure workflow. The whole process takes roughly 24-48 hours from the first tap of the card to the deposit of cash into a merchant’s bank account. It’s broken into two phases: the transaction and the settlement.

Phase 1: The transaction

The first part of the payment processing workflow is the payment approval process. As soon as a customer initiates a transaction, several events occur in rapid succession: 

1. The gateway captures critical data: The payment gateway will capture critical customer information like their name, payment credentials, and other identifying details. Then, it encrypts that data so it stays safe. 

2. The gateway forwards that information: Once encrypted, the data gets sent to a merchant service provider. The merchant service will then validate the information and forward it to the card processing network associated with the card. 

3. The processing network communicates with the issuing bank: In seconds, the processing network communicates with the issuing bank and provides the transaction details. The issuing bank will then complete extra verification checks and confirm whether there are enough funds to cover the transaction. 

4. The processing network gives the go-ahead: Once the issuing bank gives the all clear, the processing network will decide to accept or reject the transaction. That decision then gets relayed back to the merchant terminal or gateway so the customer can finish the transaction. 

5. The customer can walk away with their purchase: Each of these payment processing steps happens fast. All it takes is a few seconds, then the customer can walk away or close their browser window. 

The transaction is a large multi-step payment flow, but no funds are actually exchanged in it. That’s when settlement and reconciliation come in. 

Phase 2: Settlement and reconciliation

Instead of immediately receiving cash after a transaction, merchants receive authorisation codes for approved transactions that must be forwarded to their payment processor. The processor will forward the codes to card networks, which then forward it to the issuing bank. 

At that point, the bank takes over and handles the settlement process. Within 24-48 hours the funds get deposited directly into a merchant account. 

Payment processing stays secure through a combination of data protection technologies, advanced fraud detection mechanisms, and strict regulatory compliance.

The primary methods used to maintain security include:

Tokenisation

Tokenisation involves substituting sensitive payment card information with a unique placeholder, known as a "token". By using a token, merchants can process charges, perform refunds, or void transactions without ever storing the actual card data on their systems, significantly reducing the risk of exposure.

Encryption

Technologies like Point-to-Point Encryption secure cardholder data during transmission. This ensures that clear-text payment information is never accessible within the merchant's network.

Address Verification Service (AVS)

AVS acts as a fraud-prevention tool, particularly for online (card-not-present) transactions. It verifies the cardholder's submitted billing address against the address on file with the card issuer.

Artificial intelligence and advanced anti-fraud measures

Payment processors conduct real-time checks using parameters like the card's country of issue and previous payment history to gauge the legitimacy of a transaction. Modern platforms also deploy AI and machine learning to detect fraud in real-time, reducing false declines while optimising the overall conversion rate.

Security standards and compliance

Robust payment solutions must adhere to strict regulatory standards, most notably PCI DSS (Payment Card Industry Data Security Standard) compliance. Processors also operate in the background to ensure that all transactions strictly comply with the specific regional rules and standards of the country where the business operates. 

Optimised payment processing reduces costs, increases conversion, and even opens up entirely new ways to make money.

Reduced transactional and operational costs

Every transaction has a price tag, but smart processing keeps those costs down:

• Intelligent routing: Some processors use AI to send payments through the most cost-effective networks automatically.

• Local acquiring: Processing payments locally instead of cross-border helps you avoid expensive international fees and keep conversion rates high.

• Cheaper payment methods: Local payment methods save businesses an average of 49% per transaction, compared to credit and debit cards.

• Operational ease: A single, unified platform automates manual tasks like reconciliation. This frees up your team for higher-value work.

Increased conversions and revenue

A streamlined payment flow ensures you don't lose customers at the finish line:

• Higher conversion rates: Advanced fraud detection can tell the difference between a scammer and a loyal customer, which reduces false declines and boosts success sales.

• Reduced cart abandonment: By offering a customer’s preferred local payment method and automatically keeping card details updated, you stop sales from falling through.

Unlocking new revenue streams

For SaaS companies and platforms, payments can transition from an expense to a profit center. 

• White labeled service: By white-labeling payment services, platforms can offer financial tools directly to their users. 

• New revenue through fees: Instead of paying a third party, you can keep a share of the transaction and interchange fees.

The payment processing platform you use needs to match your business needs. When evaluating, consider a platform’s security features, its global footprint, currency options, and integrations. 

Other critical factors to consider include:

• The quality of the customer checkout experience

• A unified reliable architecture with minimal points of failure and consistent uptime

• The availability of real-time analytics and reporting

• Dependable 24/7 customer support

• The overall total cost of ownership, which includes transaction and setup fees

You should also look at the architecture of the platform. At Adyen, payment processing is part of our Unified Payments solution, which lets you connect payments data across your entire organisation. That way you can deliver consistent, smooth payment experiences across all channels and markets through one platform.

In a world where customer expectations and security threats are constantly evolving, your payment processing strategy cannot afford to be static. By understanding the journey of a transaction, you can optimise your operations, reduce unnecessary costs, and provide a frictionless experience for your customers. Curious how to reduce the overall costs of payments? Download our report to learn how things like intelligent routing and local payment methods can help you slash costs.