The payment settlement process is such a common cornerstone for businesses that it’s easy to overlook its complexity. But understanding how payment settlements work can help you optimize your business operations and receive funds in a way that works for you. 

In this guide, we look at payment settlements, including what they are, how they work, and different types of payment settlement periods. We also discuss the benefits of instant settlements, explore common settlement strategies, and answer any questions you may have about payment settlements. 

What is payment settlement?

Payment settlement is the process of transferring funds from a cardholder to a merchant. More specifically, it’s the transfer of funds from an issuing bank (customer’s account) to an acquiring bank (the financial institution accepting payments on behalf of a merchant), usually via a payment gateway. 

There are several steps involved in a payment transaction:

• • First, a payment is authorized and approved. In this step, a merchant sends a request to the cardholder’s bank to verify there are enough funds for the transaction. The bank responds by either approving or declining the pending transaction. An approved payment means that there are sufficient funds or credit available, and the card has not been reported missing or stolen.

• • The next step is the payment settlement process. This is when the cardholder’s bank (issuing bank) transfers the funds to the payment processor, which then passes on the funds to the merchant account (acquiring bank).

While payments can be authorized & approved almost instantaneously, settlement can take anywhere from a few hours to several days or weeks. This is referred to as the ‘settlement period’, and it’s generally defined by the type of transaction and issuing bank transferring the money. 

Some payment gateways, such as ZEN, are able to offer merchants instant settlement for online payments. This means businesses can start to use their earnings immediately and have better control over their cash flow.

How does payment settlement work? 

Let’s look at each step of the payment settlement process in more detail.

1. The customer makes a purchase, inserts their credit or debit card information in a checkout page, and initiates a transaction for a particular amount.
2. The payment system supports communication between the issuing bank and acquiring bank. Various security checks are completed to prevent payment fraud and the cardholder’s account is checked for sufficient funds.
3. If the customer passes the security checks and has enough funds, the transaction is approved and payment authorized. If there are insufficient funds or suspicious activity, the payment is declined.
4. The customer receives confirmation that their payment has been successful, however the funds still haven’t been transferred to the merchant’s bank account. This is when the settlement process begins.
5. At this stage, the transaction details are verified and the banks agree to debit and credit the accounts of each party. This is called the ‘clearing’ stage.
6. Finally, funds are transferred from the issuing bank to the acquiring bank. This can happen in numerous ways, such as through a payment gateway, wire transfer, or the Automated Clearing House (ACH). In some cases, such as with ZEN payment gateway, payments are settled instantly.
7. The payment is settled when the funds have been deducted from the cardholder’s account and arrive in the merchant’s account.

Types of settlement periods 

Payment settlement periods will differ depending on the issuing bank and the type of transaction initiated. As mentioned earlier in the article, some gateways support instant settlements while other payments can take hours (same-day settlements), days, or even weeks. 

Instant settlements mean a payment is settled and funds transferred to the merchant’s account immediately. This happens even on weekends, evenings, and public holidays. With same-day settlements, payments made to a business account during a specified period (e.g. 9am to 5pm) will be settled on the same day, such as close of business. 

Another option is to have a delayed payment settlement. In this case, the merchant can specify a time or day for the settlement to occur and the payment will happen accordingly. 

Benefits of instant payment settlements 

It might go without saying, but instant payment settlements offer far more benefits to both customers and businesses than same-day or other delayed settlement periods. Why? Let’s look at some of the reasons below…

• • Manage funds better: When businesses have instant access to their earnings, they can better manage and allocate their expenses. This includes paying employees, purchasing inventory, and driving business growth through marketing and other initiatives.

• • No need for loans: With delayed payment settlements, a business knows it has a certain amount of funds but no access to them. As a result, they might depend more on short-term loans to pay employees or make necessary purchases. Instant settlement means there’s no need to rely on loans as the funds a company has earned are immediately available.

• • Less payment costs: When a business uses a payment gateway that offers instant settlement, they’re less reliant on card payment schemes and the added fees and less-than-favorable bank foreign exchange rates that come with them.

• • Better financial projection: Businesses that receive instant settlement can better plan their financial goals by estimating exactly how much funds they’ll have at any given moment.

• • Easier refunds & chargebacks: Payment reversals like refunds and chargebacks are less costly to a business that receives instant payment settlements. This is because they can more easily reverse the payment without incurring any losses for those transactions.

Examples of settlement strategies

Despite the numerous benefits of instant settlements, they’re not always the best option for every business. Depending on their requirements, a merchant may choose to adopt different payment settlement strategies. Below are some examples.

• • Brick & mortar store: Physical stores, like grocery or department stores, authorize and settle payments as quickly as possible because the customer will be leaving with their purchased goods immediately.

• • Online store: In the case of online stores, credit or debit card payments can be settled instantly or they may be delayed until the merchant has shipped the order to their customer.

• • Hotel: Hotels authorize transactions at the time of booking but usually will not settle a payment until after the guest has checked out. This makes it easier to accommodate for cancellations, extensions, or room upgrades.

• • Restaurants: Some restaurants take a customer’s card details at the time of booking and hold a deposit in case of cancellation. They also tend to authorize a transaction when a customer pays but delay settlement until after a tip has been given.

Merchants who postpone the settlement process should keep in mind that payment authorization response codes give a real-time update of a cardholder’s account status. Just because a customer has sufficient funds at the time of transaction, it doesn’t mean that they will still have those funds when it’s time for payment settlement. This can lead to merchants not receiving payment from their customers with delayed settlements. The best way to get around this issue is to use an authorization hold. 

Questions about payment settlements

Below, we answer some common questions that you may have about payment settlements and the card payment process. 

What is an authorization hold?

An authorization hold is recommended for merchants that rely on a postponed settlement process. As outlined earlier, this can help prevent declined payments in cases where customers had funds at the time of authorization but not during settlement. 

Here’s how authorization holds work:

• • Customers initiate a transaction using a credit or debit card.

• • When the transaction has been authorized by the issuing bank, you can place an authorized hold on the transaction.

• • This holds the authorized transaction amount in the cardholder’s account and prevents them from spending the money on something else.

• • By ‘locking’ the transaction amount in place, it guarantees to the merchant that the funds will be there when the pending transaction is settled.

What’s the difference between gross and net settlement? 

Whether you run an online store or a brick-and-mortar business, you can choose to have your funds deposited on a gross or net settlement basis.

• • Gross settlements: With gross settlements, all the funds you’ve received in a particular day are settled in real-time and deposited without any deductions or adjustment for fees. This means you’ll be liable to pay card issuer fees later. Because different card issuers charge different fees, the amount you pay may vary each day depending on the cards your customers have used.
  • Net settlements: With net settlements, all your transactions for the day are bundled together and paid as a lump sum, minus any card fees. This means that the amount you receive is the full amount, with no further deductions to be made.

Both gross and net settlements come with their own benefits and drawbacks. Gross settlements tend to be used for high-value or time-sensitive transactions and have a minimal risk of the bank defaulting on its debt. The drawback is that you’ll have to pay fees at a later date. With net settlements, payments are settled through a clearing house and can have a greater risk of default. On the other hand, the amount you receive is net of fees and you won’t have to worry about any later deductions. 

What’s the difference between settlement and authorization? 

There can be some confusion between the authorization and settlement stage of a transaction. 

The authorization of a payment happens as soon as a transaction has been initiated. Here, the merchant’s bank (acquiring bank) will contact the cardholder’s bank (issuing bank) to conduct security checks and check that there are sufficient funds for the transaction to be processed. If nothing suspicious is detected, and the cardholder has enough money in their account or credit, the payment is authorized and can proceed towards settlement. 

Payment settlement only happens after a payment has been authorized. This step involves the issuing bank transferring the funds from the customer’s account to the payment processor or payment gateway, where it’s then passed on to the acquiring bank. Depending on several factors, this settlement can happen instantaneously, in a few hours, or several days or weeks. 

Does settlement happen immediately after authorization? 

This depends on the transaction and the business. For example, in brick-and-mortar stores, settlement happens instantaneously because the customer is leaving with their purchased goods immediately. 

Other business scenarios may call for merchants to place an authorization hold, which means settlement is postponed to a later date. Some examples where this might happen include:

• • Hotels may authorize a transaction at time of booking or check-in, but hold the settlement until check-out. This makes it easier to accommodate for date changes or additional items added to the bill.

• • Online stores can authorize a transaction at checkout but only settle the payment once goods have been shipped. This can prevent issues with low stock or customers initiating a refund or canceling their order.

What is the best settlement period?

This will really depend on the type of business you run. Most payment service providers offer a three to five working day settlement period. Others, such as ZEN, offer instant settlement to merchants with a ZEN account. 

Generally, instant or same-day settlements allow small business owners to better manage their cash flow and forecast financial projections more accurately. If you’re looking for a payment gateway, choose one that offers instant settlements so that you have that option should you ever need it. 

Instant payment settlements with ZEN

With ZEN payment gateway, your income from online payments is transferred directly to your ZEN account for you to use right away. This means you can put your earnings to immediate use: pay contractors and cover company expenses, or link your ZEN Mastercard to business tools & subscriptions and pay for them directly from your ZEN account. Better yet, you can transfer the funds to external accounts whenever you want, free of charge. 

Speak to our dedicated experts and discover why ZEN payment gateway is the best offer on the market.