How Settlement of Payment Works with a Merchant Account

A settlement of payment is a key part of the payment process because it results in the transfer of funds made by card payment from the cardholder’s account into the business owner’s merchant account and finally into their business account. Merchants agree to settlement terms with their payment service provider when they begin their business relationship.

Understanding the settlement process and how to streamline it can help business owners improve their day-to-day operations. This is because different settlement timeframes can give your business more control over the payment process.

What Is a Payment Settlement?

The settlement of a payment is the last stage of the payment process. In it, the acquiring bank collects funds from the issuing bank through a payment gateway. The merchant’s account will then receive the money minus the corresponding processing fees.

The time required to receive a settlement depends on several factors, including your payment processor, the region(s) involved (if transactions are domestic or international), the industry the merchant works in, and other factors we discuss below.

If you notice your settlements are taking longer than they should, it could be that your merchant provider isn’t providing instant authorisation. Consider working with a more reliable merchant services provider if this is the case.

How Does Payment Settlement Work With a Merchant Account?

Payment settlement is a huge operation worldwide. In the first half of 2023 alone, large-value payment systems settled 85.9 million payments in Europe, totalling €282.7 trillion in euro payments.

For small businesses, understanding payment settlements involves an understanding of how they fit into the bigger picture of payment processing and how businesses process credit card transactions:

1. Initiation

The customer makes a credit card payment online. This initiates a payment request.

2. Authentication

Your payment gateway encrypts the data used to make the payment and performs fraud checks to ensuresecure payment processing. This information is then shared with the acquirer. The acquirer subsequently sends the information to the card schemes where further risk analysis is conducted.

3. Authorisation

When these checks are complete, the information is passed on securely from the acquirer to the issuing bank. The issuing bank then proceeds to:

Verify the details associated with the customer’s account.
Confirm the cardholder has sufficient funds to complete the purchase.
Validate that the card is legitimate and that there are no signs of it being compromised or stolen. If no issues are flagged, the issuing bank will then authorise the payment.
The customer and merchant will receive confirmation that the payment went through successfully. However, funds won’t be transferred from the customer’s account to the merchant’s bank until the payment is settled.

4. Clearing

During the clearing process, funds are subject to a reverse verification process with the corresponding card schemes and the issuing bank. Banks communicate via a payment network so that different financial institutions can process the payment instructions when they receive them.

5. Settlement

There are two main phases in the settlement process:

Card schemes—for example Visa or Mastercard—debit the customer’s issuing bank account and credit the funds to the acquiring bank. The interchange and network fees may be deducted at a later date depending on the type of settlement.
The acquiring bank settles and transfers funds to the merchant’s account as stated in the merchant’s agreement with the payment service provider.

How Long Does Payment Settlement Take?

There can be some confusion about how long payment settlement takes because the authorisation stage is almost instantaneous. However, because more steps are involved during the payment process before the transaction is settled, the time needed to settle a payment can differ. This will depend on:

Agreements with your payment service provider: Payment service providers offer different services that may affect the time settlement takes. The payment system, their fraud and risk mitigating procedures, and amounts that need to be deducted can all affect how long settlement takes.
Technical issues: There are many players in the settlement process, and technical problems at any stage can delay the process. Banks carrying out maintenance work, connectivity issues, or bugs can cause setbacks.
The merchant’s industry: Some businesses operate within different honour periods depending on the risk they perceive within the industry. For example, some merchants may work with longer honour periods if their business has a higher risk of last-minute changes or cancellations. More on this below.
Payment type: International payments take longer to process and clear compared to domestic payments. Factors like business hours and international banking policies can affect settlement time.

Why Is Authorisation Necessary?

The authorisation process is the pivotal moment in payment processing. Essentially, it’s when the issuer gives the thumbs up for the transaction to go ahead.

Payment authorisation is so important because it helps prevent fraud and chargebacks. It also ensures your customers have sufficient funds to cover their purchases. This streamlines the payment process and prevents additional fees for dishonoured payments.

The Difference between Capture and Settlement

Capture and settlement are both parts of card transaction processing, but cover different aspects of the process.

In a nutshell, a capture is when the merchant’s acquiring bank sends a request for funds to be sent while settlement is the actual movement of the funds from the cardholder’s bank account to the merchant’s.

The Difference between Gross and Net Payment Settlement

Gross and net payment settlements refer to the amount before and after fees are deducted from the merchant’s account:

Gross settlements are settled without immediate deductions. The necessary deductions are subtracted from the merchant’s bank account further down the line; this period will be agreed upon with the payment service provider.
Net settlements take out the fees as soon as funds have been settled. The merchant will then receive their net earnings with no further deductions required.

Agree on Your Settlement Type With Your Payment Service Provider

You will agree to one settlement type or another with your payment service provider. They will explain the deductions you’re liable for. Typical deductions include gateway fees, interchange fees, and card scheme fees, among others.

Payment Settlement Strategies for Different Industries

Looking at different settlement periods in the context of different industries can help business owners understand the bigger picture. Supermarkets or other retail stores settle authorised transactions immediately. This is because customers pay and leave with the goods, so the whole payment process is complete.

However, some businesses benefit from a delay in settling payments. For example:

Some restaurants may authorise a transaction when the customer pays the bill but might wait to settle it in case there’s a tip that changes the total price.
An e-commerce store will authorise payments during the checkout process. However, they probably won’t settle it until the next day when they confirm the products are in stock and can be shipped.

If you postpone settlement for any reason, be aware that authorisation codes respond to the cardholder’s account status at the time of purchase. It doesn’t guarantee that they’ll have sufficient funds when you settle. Make sure your merchant services account offers the option to use a card pre-authorisation charge to place a hold on the funds and avoid the situation of not being able to complete the transaction.

Personalise Your Payment Settlement Needs

Because every business and industry is different, a one-size-fits-all approach to payment processing simply doesn’t make sense. Businesses can benefit from personalising their operations to suit the challenges they face in their industry.

Working with a payment processor that understands your industry and can tailor a package that suits your business will help your payment system work for you. This, in turn, will protect your revenue and help you maximize your profits.