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How Online Payments Work

As a business owner or founder, you have to collect money from your customers or manage financial transactions. Payment processing or online payment processing is a must, especially if you are in a B2C business.
With all the API and documentations available, setting up an online payment processing solution may sounds very easy. But making a right choice and understanding it inside out is a pain for many. Even if you are hi-tech.
So lets take a stab at how it works. Starting with a typical credit card payment processing mechanism in physical environment.


You walk up to a Starbucks; order a coffee and pays with your credit card (say you have a Visa card
There are 5 entities involved in the entire payment process that takes upto 3 sec at max.

  • You, as in a CUSTOMER
  • Your Bank, that issued you the credit card, also called ISSUER BANK
  • Starbucks, as in a MERCHANT
  • Merchant’s Bank, also called ACQUIRING BANK (say Citi Bank)
  • Credit Card Processor, also called PAYMENT PROCESSOR or card associations (in this case Visa; could be Master Card, American Express, Discover)


  • You swiped your Chase Bank credit card on the EMV POS machine, and entered your pin
  • The Merchant sends the information to his bank, i.e. ACQUIRING BANK
  • ACQUIRING BANK sends the information to the PAYMENT PROCESSOR (in this case Visa)
  • Visa, from that information, determines the ISSUER BANK who issued the card to the customer i.e. Chase Bank
  • ISSUER BANK checks and approves if you have credit available on your credit card and your transaction looks legit, otherwise it declines the request
  • Approval is sent back to Visa (Payment Processor), that sends it to ACQUIRING BANK, that intimate Starbucks of the success
  • Cashier at Starbucks sees the Approval on the EMV machine, gives you the receipt and hands your Cappuccino to you


  • At the end of the day, Starbucks sends all the transactions to the ACQUIRING BANK (Citi Bank).
  • It sorts out all requests according to various cards and sends it to respective card associations.
  • Card associations pays to the Merchant’s bank i.e. ACQUIRING BANK.
  • MERCHANT’S BANK then transfers all the amount to Starbucks account.
  • Card associations then bills the ISSUING BANKS and receive their amount from them. In this case Chase Bank paid in advance for you.
  • ISSUING BANK then sends the monthly bill to You i.e. your credit card statement summary.
  • You settle your credit card bills.

Payment Card Industry has matured over decades and has established Standard Operating Procedures to handle card processing issues and frauds. No matter where you are and who you are, you can call the help line and they will sort it out for you. Usually you are covered against any fraudulent transaction through various insurance schemes. But this doesn’t establish a reason to be not careful and avoid long times before claims are adjusted.


Online Payments are quite similar to what we have discussed above. The difference is that the card is Not present physically at the POS. Hence the involvement of a PAYMENT GATEWAY.

PAYMENT GATEWAYS are service providers that authorize payments for online shops. Imagine you are establishing an online business (ecommerce store to sell books) and want to receive online payments, you will be connecting your web application to a payment gateway to accept payments.


Online Payment is a three-step process:
Authorization: After the buyer selected their books and pressed Checkout, a request to be charged on the card is placed through the web portal. Payment gateway scans the information submitted i.e. card number, expiry date, bill amount. If the data is missing, payment gateway will issue an error. If data is good, payment gateway requests the payment processor (credit card associations) and it’s the same process as described in regular card payments above.

If funds are available, the transaction is assigned an authorization code. Puts the funds on hold and reduces the customer available balance. A positive response is sent back to the Acquiring Bank and the portal accordingly.

Capture: Instructs that the funds on the card should be transferred from customers account to the merchant account. Capture can happen immediately at the time of authorization, or at a later stage. Unless the capture occurs, funds stay on hold. Authorization expires after a certain time period if capture doesn’t happen.
Ability to capture immediately or at later stage is governed by Merchant’s business process.

Settlement: Transfers the funds from customer account to merchant account. When a transaction is assigned an authorization code it is in 2 possible states, i) authorized / pending capture ii) Capture / pending settlement. When the settlement happens, Payment gateway transfers all the transactions amount to the Merchants Bank


Authorize and Capture — Typical transaction for immediate sale and settlement of orders

Authorization Only — Authorization done, pending capture. Authorization code issued. Typically used by reservations. Expire in 30 days.

Prior Authorization and Capture — Next step to Authorization Only transaction if a settlement is intended. Merchant provides the authorization code. Status changed to Captured/Pending Settlement and settlement is done at the next cut of time of transaction.

Credit (refund) — Allowed to refund the settled transaction. Transaction must be refunded to the same card. Must be done within 120 days of the original transaction.

Void — Allows the merchant to cancel the unsettled transaction


  • Facilitates information between payment portal and acquiring bank
  • Protect credit card details by encrypting sensitive information
  • Guarantee fraud protection and available almost everywhere


  • Consider the setup fee charged by payment gateways
  • Security of customer info and transactions
  • Time taken to process transactions and credit money to your bank
  • Flexibility to offer multiple currencies and conversions
  • Availability in various countries
  • And most important, Transaction rates they charge per transaction.

Get in touch with Virtual Force and let us know how we can help you!