Payment Settlements | A Complete Overview

If you’ve got an online business, understanding the way payment settlements work is truly important for your business choices. And since it can be difficult to understand it all at first, today we’re going to go to break down the basics, from money flow and currency exchanges to fees and timing. 

But first: payment settlements refer to the process where transactions completed between buyers and merchants are finalized and the funds are transferred from the buyer's bank to the merchant's business account. 

This involves multiple stages, starting from the moment a customer makes a payment until the funds are deposited into the merchant's bank/business account. During this process, the payment goes through several checks and balances, involving banks, payment processors, and card networks like Visa or Mastercard, to make sure that the transaction is valid and authorized.

The settlement process includes the calculation and deduction of any applicable fees, such as transaction fees, processing fees, and potentially currency conversion fees if the transaction involves multiple currencies. The final amount, after these deductions, is what gets deposited into your merchant bank/business account.

The time it takes for a settlement to occur can vary, depending on the payment method and currencies used, the banks involved, and the specific terms agreed upon between you, the merchant and your payment service provider. Settlements are a very important aspect of the payment processing ecosystem, allowing you to receive your funds and to continue operating your businesses effectively.

Let’s dig a little deeper: 

The Money Flow Process

Here's a step-by-step breakdown that clarifies each stage of the process:

1. Initiation: A customer makes an online purchase, initiating a payment request by entering their payment details on the merchant's website.
2. Authentication: The payment gateway encrypts the customer's payment data and conducts fraud checks. The data is then sent to the acquirer and further to card schemes for risk analysis.
3. Authorization: The issuing bank verifies the cardholder’s details, checks for sufficient funds, and confirms the card’s legitimacy. If approved, the customer is notified of the successful transaction, though funds are not yet transferred.
4. Clearing: The transaction details undergo a reverse verification by the card schemes and issuing bank to ensure accuracy.
5. Settlement:

• Card schemes debit the issuing bank and credit the acquiring bank, deducting fees as per agreement.
• The acquiring bank transfers the funds to the merchant's account based on the merchant's agreement with their payment service provider.

This process kicks off the moment a customer makes a purchase, with the transaction initially occurring in the customer's local currency. This is the first stage where currency exchange may come into play, as the funds make their way through the payment ecosystem, potentially undergoing multiple currency conversions before they finally settle in your merchant account. 

If the funds then need to be converted into another currency to be deposited into your business bank account, it might need to go through multiple foreign exchange (FX) conversions. Each conversion step along the way introduces potential for additional costs, as FX rates and fees apply. 

To understand the impact of FX along the way, let's deep dive into a hypothetical example (graph below). In a scenario involving multiple currencies and conversions, particularly with currencies not directly supported by all parties involved, the process becomes more complex. Let's consider a Swedish customer (using SEK) purchasing from a U.S.-based website (listing prices in USD) with an acquirer that only deals in EUR, while the merchant wants to receive the funds in GBP. Here’s how this complex currency scenario unfolds:

Understanding this flow is useful for eCommerce owners, as it allows you to understand how to optimize payment processing to minimize currency conversion steps and associated costs. 

Plus, only by knowing this can you make informed decisions about selecting payment service providers and negotiating terms that favor your business's financial health.

Like-for-like settlement

The ideal scenario for any eCommerce business is to have a like-for-like settlement, where the entire settlement process is carried out in one currency, avoiding unnecessary FX fees. 

This approach simplifies the financial management of cross-border transactions and provides a predictable cost structure. To facilitate this, you should collaborate with a Payment Service Provider (PSP) that maintains a diverse network of acquirers. 

Such a PSP can offer an extensive range of settlement currencies, which in turn can mean not needing multiple FX conversions, so overall lower FX fees.

By broadening your acquirer network, you also get the flexibility to route transactions through the most cost-effective channels. This means that you can now optimize each payment's currency pathway for efficiency and cost savings. 

Understanding Fees

Two primary types of fees are associated with the settlement process:

• Processing Fees - these refer to all fees related to the actual processing of payments, including scheme fees, payment gateway charges, and more. They are part of the cost of doing business in the digital payment ecosystem. These fees belong to the operation of the digital payment infrastructure. Processing fees are influenced by several factors, including the type of card used, the transaction's geographical origin, and the risk level associated with the transaction type. 
• Settlement Fees - these are the fees for when the acquirer pays out to your merchant business bank account. They are essentially the cost of transferring the settled funds into your account. The specific rate of these fees can vary based on the terms agreed upon with your payment service provider and the acquirer.

Understanding these fees allows you to make accurate forecasts of your operating costs and to negotiate better terms with service providers.

Timing is Everything

The settlement time can vary significantly depending on your location, the acquirer, and the card network. For instance, transactions between UK-based entities can result in same-day settlements, thanks to streamlined processes and proximity. 

However, international settlements, or those involving acquirers and banks in different countries, may experience delays.

Frequency and Delay Mechanisms

The settlement cycle is formed by the payout frequency (weekly/daily) and the settlement period (T+1, +2, etc.). This is usually agreed by the merchant and the PSP/acquiring bank and is tailored to manage risk and make sure that your merchant account stays balanced.  

Now let’s quickly clarify what it means. You might see it like “Weekly T+2” in your contract with a PSP/acquiring bank. Let's break down what "Weekly T+2" means:

• Weekly: This indicates the frequency at which payouts are made. In this case, it means that the settlements are processed once a week.
• T+2: This term refers to the settlement period. "T" stands for the transaction date, i.e., the day on which the transaction occurred. The "+2" means that the settlement occurs two business days after the transaction date.

Putting it all together, "Weekly T+2" means that once a week, transactions from the previous week are settled and the funds are transferred two business days after the transaction date. For example, if transactions occurred on a Monday, the settlement for those transactions would be processed on Wednesday (assuming no public holidays affect the business days), but the actual payout to the merchant or recipient's account would be grouped with other transactions of the week and completed on the designated weekly payout day.

A rolling reserve is another risk mitigation tool, where a percentage of transactions (typically around 10%) is held for a certain period (e.g., 180 days) before being released. These measures are designed to protect both the service provider and the merchant from potential financial discrepancies.

Conclusion

Embracing a multi-acquirer strategy broadens market access and minimizes foreign exchange fees and enhances operational resilience. The right Payment Service Provider can be a strong business ally in streamlining your payment processes, keeping your business competitive and financially healthy.

At CatalystPay, we're dedicated to empowering eCommerce businesses with the knowledge and tools to grow in the digital marketplace they operate in. Whether you're exploring the best ways to manage currency conversions or seeking to optimize your settlement processes, we're here to guide you every step of the way.