What is payment settlement?

Payment settlement is such an everyday occurrence for most businesses that it’s easy to give little thought to its complexity and the variety of ways it can be achieved. 

However, understanding exactly how payment settlement works is essential to optimizing your business operations, as different settlement periods and strategies can impact liquidity and even customer relationships.

Below, we explain the payment settlement process, how it relates to payment authorization, the difference between gross and net settlement, and the various settlement strategies that merchants can adopt. 

What is payment settlement? 

Payment settlement refers to the process of the issuing bank transferring funds from the cardholder’s account, via a payment gateway, to the acquiring bank - the financial institution that accepts card payments on behalf of the merchant. 

Following approval and authorization, it is the final step in the chain of events begun when a customer initiates a transaction. While approval of the transaction can happen almost instantaneously, it can take several hours, days, or even weeks for the funds to be settled in the merchant’s account. Settlement periods are affected by many factors, including the type of transaction and the issuing bank responsible for transferring the money. 

How does payment settlement work?

The payment settlement process is as follows:

• The customer initiates a debit or credit card transaction for a certain amount
• The issuing and acquiring bank communicate immediately via the merchant’s payment gateway 
• Provided the customer has sufficient funds and passes the required security checks, the issuing bank can approve the transaction and instruct the merchant to authorize the payment 
• The customer may now receive confirmation that their payment has been successful. However, their funds are not transferred immediately to the merchant - this is where the settlement process comes in
• The settlement period largely consists of clearing - the time between authorization and settlement where details are verified and the banks agree to debit and credit the accounts of each party. This communication is conducted through a payment network, which facilitates the exchange of transaction data. 
• Funds can be transferred in a number of ways, including electronically, by wire transfer, or through the Automated Clearing House (ACH), a national payment system in the US. The advent of Faster Payments networks has allowed for much quicker settlement of funds, sometimes in near real-time
• Once the funds have been deducted from the customer and arrive in the merchant’s account, the payment has been settled

Why is authorization good for payment settlements?

Authorization, where an issuing bank receives a transaction request and decides whether or not the payment should be approved or denied, is essential to payment settlements.

If a transaction is declined due to insufficient funds or incorrect cardholder information, the issuer cannot begin the process of settling funds in the merchant’s account. In these cases, known as a soft decline, the merchant can ask the customer to reattempt the transaction by reentering their details or by trying a different card. However, in some cases, the card may have been reported lost or stolen, signaling attempted fraud, and the payment should not be retried - a hard decline.

Authorization can also play a role in the length of the settlement period if, for example, you need to delay the settlement of funds because you’re a hotel that only takes the funds when your guest checks out. In this case, once the issuing bank has approved the transaction, you can place an authorization hold on the payment. This ensures that, while the money is still in the customer’s account, they can’t spend that amount on anything else, guaranteeing that it will be available for settlement at a later date.  

Learn more: What is a pre-authorization charge?

What is the difference between gross and net settlement?

The money you make on any given day can be deposited on either a gross or net settlement basis, depending on your preferences. Gross settlements are settled in real-time, independently of other transactions and without any deductions or adjustments for fees.

With net settlement, all your transactions are bundled together and settled in one sum at the end of the day, or another agreed time-period, minus any fees.

Both come with their benefits and risks. Because they are immediate, gross settlements are often used for high-value or time-sensitive transactions, which minimizes the risk of the bank defaulting on its debt. However, you will have to account for any fees at a later date.

Net settlements are cleared and settled through a clearing house. While there is a greater risk of default, the sum you receive at the end of the day is already net of fees.

Payment settlement strategies for merchants

Not every merchant will adopt the same practices when it comes to their payment settlement strategy, which will depend on the specific requirements of your business. Here are some examples:

• Brick and mortar store - the merchant will look to settle an authorized transaction as quickly as possible because the customer is expecting to purchase the goods and leave immediately
• Online store - following a customer purchase, the funds may not be settled until the merchant has confirmed the payment and shipped their order, which could be one or two business days 
• A hotel - as in the example above, hotels usually authorize a transaction, but may not take the payment immediately in case of cancellation or an extended stay
• A restaurant - some restaurants take card details when a customer books a table so that they can hold a deposit that can be taken as a charge if the customer fails to show up for their reservation. They can also delay setting a bill payment until after the tip has been given, which increases the total amount

Checkout.com as a payment gateway

Payment gateways pass the information necessary to authorize a transaction and settle funds between the issuer and merchant. They can be used for both card and alternative payment methods.

As a payment gateway, Checkout.com can help you with all your payment settlement needs. Our end-to-end solution acts as both acquirer and processor, meaning we can process and settle transactions more quickly. We can authorize payments in near-real time, and then, through our platform, allow you to control when to capture your customers’ reserved funds - anything up to seven days after authorization. 

We also give you access to actionable data and insights that you can use to optimize your payments experience, improve acceptance rates, and grow your revenue.