Payment Authorization vs. Settlement

What’s keeping your payment system from its maximum potential?

Payment authorization and settlement are two processes handled by financial entities rather than merchants directly. Once a payment request is sent, a merchant’s or marketplace’s only remaining responsibility is to wait for a payment approval or denial. 

Yet, the authorization and settlement processes are not to be ignored. 

Without proper optimization, these processes can be time-consuming and error-prone, driving customers away from your business. Seamless payment authorization and settlement can be the difference between exceptional revenue and a year in the red. 

What is payment authorization?

Payment authorization is the process of sending a payment request to a customer’s issuing bank for approval. The issuing bank performs various checks to verify the request before sending an approval or denial back to the merchant or marketplace where the payment was initiated. 

Authorization benefits everyone involved in a transaction by keeping it secure throughout the payment process. Without a well-designed payment authorization workflow, customers can experience frustration at checkout and serious risks to the payment data transmitted. 

For issuing banks and other financial entities, payment authorization is an essential component of both their security and compliance strategies. Financial institutions facilitating transactions hold a tremendous amount of legal liability, leading to the use of strict authorization mechanisms to detect and prevent fraud.

A successful payment authorization process is important for businesses for many reasons, such as revenue collection and customer retention. When your authorization process is slow or unreliable, you may find your business losing crucial revenue and losing customers to more efficient competitors. 

The core purpose of payment authorization is to legitimize transactions before releasing funds.

Authorization ensures a customer has entered the correct payment information and credentials to access funds in a specific account. Issuing banks take on the burden of payment authorization, but the process benefits merchants, marketplaces, and customers just as much. 

How payment authorization works

When a customer initiates a payment, whether online or in-person, the authorization process begins. The payment details (i.e. card numbers, CVC codes, addresses, etc.) are sent to your payment gateway, which then forwards the information to the relevant financial entities (such as issuing and acquiring banks).

Once the issuing bank receives the data and payment request, it evaluates multiple factors, including:

• Account balances
• Geographic origin of the payment
• Method of payment (online, in-person, etc.)
• Spending limits and behaviors

If everything checks out, the issuing bank sends an approval code that is transmitted all the way back to the payment gateway before eventually reaching the merchant, who can then send a payment confirmation to the customer. Should the bank find issue with the payment request, they can send back a decline code that details the reason for the payment failure. 

What is settlement? 

Settlement is the process of moving funds from one account to another after a payment has been authorized. It is the last step before the transaction is complete. 

After approving a transaction, the issuing bank authorizes the transfer of funds from the customer’s account to the merchant’s payment processor. The processor can then transfer the money to your acquiring bank, which sends the funds to your merchant account. 

While some transactions can be settled and reconciled instantly, others can take days or weeks to complete. The variance in settlement times can be based on many factors, such as:

• The goods, services, or equities traded
• The starting and ending points of a transaction
• Regulatory standards for settlement 
• Payment method used

Settlement involves a series of backend steps that ensure the proper movement of money from the sender to the receiver. A streamlined settlement process can be critical for merchants and marketplaces who need an efficient and reliable checkout experience to offer customers. Waiting days to weeks for a payment to settle can cause stress for both your business and your customer. 

How settlement works

The settlement process begins when the merchant submits captured payment authorizations for settlement. These are typically batched and sent to the acquiring bank or payment processor at the end of the business day, though some can be sent, settled, and reconciled in real-time. 

Your acquiring bank works with the customer’s issuing bank or card network to coordinate the transfer of funds. The money passes from the issuing bank to a payment processor before being delivered into your merchant account. During this process, the financial entities make sure the credits and debits match up, as well as apply the applicable fees and currency conversions as needed.

The timing of a settlement cycle can be a bit more complex based on the payment method used. For example, ACH transactions are typically settled on the next business day, while wire transfers can be settled within hours. Settlement speeds can be a huge factor to consider when making business payments as well, as you want to choose the options that will reach your suppliers and recipients the fastest. 

How payment authorization and settlement differ

Payment authorization and settlement are distinct stages of the payment lifecycle.

Authorization comes before settlement and is used to validate and approve payments. When a transaction initiates, the authorization process automatically begins as well. A hold may be placed on the customer’s account during this process for the payment amount. 

However, authorization does not involve transferring the funds to the merchant. The temporary hold simply ensures the funds are available for the payment capture process. 

Settlement occurs once the funds have been captured and are ready to be sent to their endpoint. This process involves more complex, backend operations, often handled in batches to optimize efficiency. Whereas authorization can occur in seconds, settlement spans a longer timeline, typically one to three business days, depending on factors like payment method and jurisdiction. 

A significant difference between the two is risk exposure and liability. During the authorization process, the bulk of the risk falls at the starting point with the merchant’s payment system. After settlement has occurred, the risk shifts to the banks and payment processors to deal with any post-transaction challenges, such as chargebacks or payment disputes. 

Given the differing risks of a transaction at each stage, it’s highly important to use efficient workflows for both authorization and settlement processes that can minimize delays and errors. 

Beyond the technical processes, payment authorization is also much more focused on security and compliance, while settlement is more reconciliation-centric. Many authorization mechanisms use advanced fraud detection and prevention measures to validate payments with the utmost precision. At the same time, settlement technologies have changed as well to support smoother money movements. 

How authorization and settlement fit together in the payment process

Authorization and settlement are integral components of the payment process. Their roles are sequential but interdependent, ensuring both the verification of payment and the transfer of funds.

The process begins when a customer uses a credit or debit card to make a purchase, either online or in-person. At this point, the merchant sends an authorization request to the card issuer via the payment gateway and acquiring bank. This request includes transaction details such as the card number, expiration date, and purchase amount. The card issuer evaluates the request by checking the customer’s account for sufficient funds or credit, verifying the card’s validity, and screening for potential fraud. 

An approved response places a temporary hold on the customer’s account for the transaction amount, reserving it for later settlement. If the request is declined, the transaction cannot proceed.

With approval, the merchant can move to the settlement stage. Settlement involves submitting the authorized transactions to the acquiring bank, which coordinates with the card networks and issuing banks to transfer funds. During this stage, the customer’s account is debited, and the merchant’s account is credited, finalizing the transaction.

Authorization and settlement work together to keep transactions flowing without putting the customer’s payment information at risk at any point in the process. 

Where payment declines factor into the process

Payment declines are an unavoidable part of the payment process and can significantly affect both authorization and settlement timelines. Declines occur for various reasons, such as insufficient funds, expired cards, incorrect details, or fraud detection mechanisms. 

A payment decline typically occurs during the authorization stage. However, their impact can ripple through the entire transaction process and halt settlement entirely if not addressed quickly. 

When a payment is declined during authorization, the merchant must often seek alternative solutions, such as requesting a different payment method from the customer or reattempting the transaction. This additional interaction increases the time spent per transaction and can disrupt operational workflows, particularly for high-volume businesses. For customers, declined payments can lead to frustration, potentially jeopardizing the sale and customer relationship.

In cases where declines are part of recurring billing systems or subscription models, the consequences can be even more significant. A failed payment may lead to service disruptions, requiring customer intervention to reach a resolution. 

Excessive declines can raise red flags with payment processors, potentially resulting in additional scrutiny or higher fees for the merchant. In some cases, fraud-prevention algorithms may inadvertently increase decline rates for legitimate transactions, further compounding delays.

Minimizing the impact of declines requires you to assess the efficiency and effectiveness of your current payment system. If you can identify a common recurring cause behind your declines, you can more easily address the problem and resolve it with a new provider or tool. 

Understanding the types of settlements as a merchant

Settlements can vary greatly from one scenario to the next. 

For example, you can receive funds through one of two settlement types, gross or net. A gross settlement involves the total transaction amount being deposited into your account. You are billed at a later point by your payment gateway and other service providers for applicable fees and network charges.

Conversely, a net settlement is the amount of funds you receive after fees and charges have already been deducted. The final net positive amount is deposited into your account, reducing the amount of administrative and accounting work needed after the payment is complete. 

As far as when you will receive your payment funds, settlement times are impacted by multiple factors:

• Merchant account types: Your merchant account type and how it is risk scored can influence how long it takes for your transactions to settle. 
• Transaction volumes: Merchants with high payment volumes who maintain a lower level of risk are often granted better negotiations with payment service providers, such as faster settlements. 
• Service providers: Different gateways, processors, and banks can have their own settlement policies, affecting the time cycle of a payment made with these providers. 

How Spreedly’s Tokenization simplifies authorization and settlement 

At Spreedly, we secure and optimize your payments start to finish, from authorization to settlement.

Through products like Recover and Network Tokenization, our solutions enable you to increase your revenue and enhance the lifetime value of your stored payment credentials. 

Recover helps to resolve transaction declines quickly by rerouting failed transactions to secondary gateways according to your rules and preferences. Alone, Recover can aid you in improving your decline rates. When combined with other Spreedly solutions, however, Recover can act as a key component in a larger web of solutions designed to optimize and orchestrate your payments.

For instance, our Composer solution provides you with a streamlined workflow where you can simplify the processes for implementation, orchestration, and payment outcomes. Through this workflow, you can ensure fast settlement times with minimal disruptions, all while maintaining a core orchestration layer that keeps each moving part of your payment setup cooperating smoothly. 

Meanwhile, our Network Tokenization solution uses network tokens specific to individual merchants, creating a safer environment for transmitting payment data. Network Tokenization is a straightforward yet highly effective process that enhances payment security, improves authorization rates, and brings new life to subscription and recurring payment experiences. 

Payments have become more diverse, complex, and risky over recent years. Spreedly offers a host of tailored solutions that can simplify each of your payments, from authorization to settlement.  

Contact Spreedly today to book a free demo of our entire open payments platform. 

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