Merchant Account Basics

A merchant account is an account that is set up with a credit card processor, acquirer, or other financial institution, which makes it possible for a business to accept bank cards and electronic funds as a form of payment for products or services rendered. Merchant accounts are linked to a standard business checking account or direct deposit account (DDA) and all funds from sales are electronically deposited into this account via the automated clearing house (ACH) by the acquiring bank.

There are a lot of things that happen from the time that a merchant charges a customer's credit card to when it's authorized. The process requires multiple financial institutions and electronic transfer systems to deliver the final product.

While this process is interesting, it's not necessary to know most of the information in order to acquire and maintain the best merchant account for your business. Instead, we have described the basics flow of an electronic bank card transaction process below. When a merchant runs a customer's credit card the following process takes place:

• The terminal, software, or gateway contacts the credit card processor (referred to as a third-party processor), or the acquiring bank, with the customer's credit card and billing information along with the transaction information such as the amount of the sale.
• The processor or bank then relays the information to the issuing bank or card-issuing organization. This is the place where the customer's credit card comes from. MBNA, Citi Bank, and Bank of America are large credit card issuers.
• The issuing bank then sends an approval or decline back to the third-party processor based on a number of different criteria such as available balance, validity of the information supplied, etc.
• Once the approval (or decline) is confirmed by the issuing bank, an authorization is issued against the customer's credit balance. This means that the funds in question have been reserved for the sale.
• The transaction is then assigned an authorization number which is a code that identifies the individual transaction.
• This information is relayed back to the merchant's processing equipment and is displayed for their records so that they know the credit card has been approved (or declined).
• All authorizations are stored by the credit card equipment in something called a batch. Batches are very important and will be discussed in more detail in the next section.

Merchant processing, like any other financial service, is based almost totally on the assessment of risk. When a merchant charges a customer's credit card the acquiring bank is going to deposit funds into that merchant's bank account assuming that the merchant has delivered the product or service that they've said they would.

The processing or acquiring bank gives the merchant money based almost entirely on the assumption that the merchant has delivered the products or services that they've promised. Credit card processors have to be very careful about who they issue merchant accounts to and how the accounts are being used. The following is a hypothetical scenario of a credit card processor's worst nightmare:

Let's say that processor "A" issues a merchant account to John Doe for his new online business and gives John Doe a $20,000 processing limit. In his first month of business John Doe has a phenomenal month of sales totaling $15,000 but he never ships a single product. At the end of the month all of his customers are demanding their money back but John Doe has already closed his bank account and skipped town. In a case like this, the processing or acquiring would be stuck refunding $15,000 back to John Doe's customers.

Most well-intentioned business people do not think like this but it's the basic reason why merchant accounts are so scrutinized. Personal credit status of the business owner, the business type, processing volume, and other variables are all considered by the processor or acquirer when a business or individual applies for a merchant account. These variables and their impact will all be discussed in more detail later in this guide.

There are two basic types of merchant accounts that are generally referred to as 'card present' and 'card-not-present'.

A card present merchant account is recognized by processors as the lowest risk way of processing credit cards and refers to any type of merchant account where the customer and their credit card are present when a transaction takes place. Wireless merchant accounts and retail merchant accounts are primary examples of card present accounts. Although even the subcategories of these accounts have varying degrees of risk they are all considered low risk methods of transacting bankcards.

Card-not-present merchant accounts are seen by processors as higher risk accounts because they are set up under the assumption that a customer and their card will not be present when a transaction takes place. An Online merchant account, touchtone telephone merchant account, and mail order merchant account are all examples of card-not-present accounts.