Understanding Settlements in Payment Processing

Once a customer inputs their payment information, whether they enter it into an online payment gateway, swipe, or tap their card for in-person transactions, their transactional data will begin to quickly travel along the payment processing journey before reaching its final destination: settlements.

Each stage of payment processing is vital to ensuring a successful and secure transfer of funds. But it’s not until the settlement phase that the funds are transferred from the customer’s bank account to the merchant’s bank account. Awareness of the processes, timing variations, and common challenges of payment settlements is vital to maintaining a healthy cash flow and accurate financial reports that are crucial for doing business at any level. Everyone from small business owners to CEOs and CTOs of global corporations can benefit from the right payment processor.

So if you are currently deciding which off-the-shelf payment processing solution is right for your company, or if a custom payment solution better suits your needs, keep reading for an in-depth review of payment settlements. We cover the aspects of settlement mentioned above, as well as security measures, how international transactions may affect settlement timing, reconciliation, and future trends to keep your eye on.

What Does Settlement Mean?

Settlements represent the final step in the payment process.

Let’s get creative, imagine you just made an online purchase—your payment details are verified by the payment gateway through its authorization process, and you receive an order confirmation indicating the transaction is complete.

However, there is still one more step before the transaction is actually completed, a.k.a cleared. The next step, settlement, is where it all happens. This is when the actual transfer of funds occurs, moving from your credit card or bank account to the merchant’s payment account.

Settlements ensure that the money you paid for your purchase is safely and accurately transferred to the seller, completing the transaction. Whether you are a customer making a purchase or a merchant receiving payment, settlements play an essential role in the entire payment journey.

The Steps of Payment Processing

Let’s take a closer look at the step-by-step journey a payment transaction undergoes:


The payment process begins when a customer initiates a transaction. This can happen in various ways, such as making a purchase online, using a credit card at a physical store, or sending money through a mobile payment app.


Once the payment is initiated, the transaction undergoes an authorization process. The authorization process is a joint effort of your payment gateway and payment processor working together. The gateway sends or “passes” the information along to the payment processor, which completes the authorization, then sends the info back to the gateway. Essentially, the payment processor or issuing bank checks if the customer has sufficient funds or credit to cover the transaction amount. If the funds are available and the transaction is valid, the payment is authorized.


After authorization, the funds are captured, which means they are temporarily held and reserved for the transaction. At this point, the customer’s account balance reflects the pending transaction amount.


The clearing process involves the exchange of transaction data between banks and payment processors to ensure accurate information and validation of the transaction. This step is crucial for reconciling records and initiating the settlement process.


Finally, we reach the last step of the payment process (and the star of this article)—settlements. This is the phase where the funds are transferred from the customer’s account to the merchant’s account, completing the payment transaction. Settlements serve as the confirmation that the customer has successfully paid for the goods or services provided by the merchant. It is important to note that though it may appear that the transaction is complete, there are still potential issues and challenges that can arise after.

Now that we have an overview of the payment process, let’s explore the critical role of settlements in ensuring smooth and secure fund transfers. We will examine how settlements facilitate the transfer of funds, their significance for both customers and merchants, the security measures implemented, and the impact of settlement timings on fund availability.

How Do ACH Returns Affect Payment Processing?

ACH transactions are electronic payments that move money between banks and credit unions. They are used for direct deposits, bill payments, and money transfers. ACH is cost-effective and secure, making it a popular choice for businesses and individuals. ACH transactions usually take a few days to process, unlike credit or debit card authorizations that happen in real-time.

Because ACH transactions do not process instantly, this leads to the possibility of returns or rejections even after the transaction seems complete. An ACH return, or reject, occurs when the ACH Network fails to collect or deposit funds into a receiver’s account. These returns are denoted by specific return codes, typically starting with “R” followed by two numeric digits (e.g., R01).

Understanding ACH returns is crucial for processors and gateways, as they provide valuable insights into transaction status and help identify any potential issues with the settlement process.

Common ACH Return Codes in Settlements

Return codes in settlements refer to specific messages that indicate the status of a transaction, particularly in ACH (Automated Clearing House) transactions. These return codes provide valuable information about the success or failure of funds collection or deposit into a receiver’s account. Understanding these common return codes is needed to address settlement-related issues promptly and accurately. By identifying the reasons behind a return, appropriate actions can be taken.

Here are some of the most common return codes and their simple explanations:

R01 – Insufficient Funds: This code means that the transaction could not be completed due to insufficient funds in the sender’s account.

R02 – Bank Account Closed: The receiver’s bank account is closed, making it impossible to deposit funds.

R03 – No Account/Unable to Locate Account: The receiver’s bank account number provided in the transaction is invalid or could not be found.

R04 – Invalid Account Number: The receiver’s bank account number is incorrect or does not match the account holder’s information.

R05 – Unauthorized Debit to Consumer Account Using Corporate SEC Code: This code indicates that a consumer account was used for unauthorized business transactions.

R10 – Customer Advises Not Authorized: The receiver disputes the transaction and claims not to have authorized it.

R29 – Corporate Customer Advises Not Authorized: A corporate receiver disputes the transaction, stating that they did not authorize it.

Want a complete list of ACH return codes? Click here.

Security Measures in Settlements

The security of your payment information is of utmost importance during settlements. Payment processors and financial institutions, like credit card companies, implement robust security measures to protect sensitive customer data. Encryption (a sophisticated coding technique) is used to secure your payment details during transmission, making it virtually impossible for unauthorized individuals to access your information. Advanced fraud detection mechanisms are also in place to identify and prevent fraudulent activities, ensuring a safe and secure settlement process.

To learn the difference between encryption vs. tokenization read Payments 101: Understanding Tokenization.

Settlement Timings and Fund Availability

Settlement timings can vary based on the payment method, the financial institutions involved, and your chosen payment processor or payment gateway. Credit card payments settle instantly, compared to ACH settlement times, which can be delayed by 1-2 days. The timing of settlements directly impacts the merchant’s fund availability.

Remember, if you’re a seller, it’s important to be aware of these timings to plan your finances effectively and ensure a smooth cash flow. The risk is minimal but it’s worth mentioning that it’s not always a successful settlement. The risk associated with transaction settlements is called settlement risk and it is one type of counterparty risk.

Counterparty risk consists of three key elements: settlement risk, default risk, and replacement risk.

Settlement Risk

Settlement risk relates to the possibility of the counterparty defaulting before the transaction is completed. It is often associated with liquidity risks, especially in currency exchanges.

Settlement risk is extremely rare thanks to the standard of security measures for digital payments. Ready-made software often includes a comprehensive amount of security features, but when companies need to meet the highest levels of security, they often opt for custom payment processing software.

Default Risk

Default risk, also known as credit risk, refers to the possibility that the counterparty may fail to fulfill its obligations due to bankruptcy or inability to repay a loan.

Default risk is the most common form of risk experienced by companies when their goods or services can be purchased online with a credit and debit card or another digital payment type. ACH transactions are most prone to this risk. Yet again, the risk is still extremely minimal thanks to security measures and other safeguards implemented by financial institutions.

Replacement Risk

Replacement risk, on the other hand, involves the risk of not finding another suitable counterparty if the original one defaults. This is particularly relevant in transactions with limited potential counterparties, such as some over-the-counter derivative deals.

Challenges and Disputes in Settlements

Even after the initial settlement, there are events that can affect the state of the transaction, leading to challenges and disputes that need to be addressed. One common challenge is chargebacks. These occur when a customer disputes a transaction with their bank, leading to the reversal of funds from the merchant’s account. Chargebacks are accompanied by specific return codes, indicating the reason for the dispute, such as fraud or dissatisfaction with the product or service. Refunds, initiated by merchants due to customer requests or discrepancies in the transaction, can also impact settlements.

There are many ways that merchants can prepare for, prevent, and resolve settlement-related issues.. They can implement strategies to prevent chargebacks, such as providing excellent customer service, clear product descriptions, and secure payment processes. In case of disputes, merchants should maintain detailed records and evidence of transactions to defend against chargebacks effectively.

Settlements in International Transactions

International transactions add another layer of complexity to settlements, especially when currency conversion is involved. Payment platforms like PayPal® handle the currency conversion process. However, merchants must be aware of exchange rates and potential fees associated with cross-border settlements. Additionally, compliance with international regulations and payment network rules is essential to facilitate successful international settlements.

Reconciliation and Reporting of Settlements

Settlement reconciliation is vital for accurate financial management. Merchants use various tools and methods to reconcile settlements and compare transaction data to ensure consistency. Proper reconciliation helps identify any discrepancies and ensures accurate financial reporting. Settlement reporting plays a significant role in financial analysis and decision-making for businesses. It provides valuable insights into transaction trends, customer behavior, and overall business performance.

Future Trends For Settlements

The payment industry is continuously evolving, and settlements are no exception. Emerging technologies, such as blockchain and real-time payment systems, are reshaping the settlement landscape, making transactions faster, more secure, and more efficient. As these trends unfold, businesses need to stay updated and adapt to the changing settlement ecosystem to remain competitive and provide better customer experiences.

Settlement Timing Is Key to Success

Understanding settlements is essential for businesses and customers as it impacts financial management, customer satisfaction, and dispute resolution. By gaining an understanding of settlements and embracing future trends, businesses can navigate the payment landscape confidently and build stronger relationships with their customers. As we continue to witness innovations in payment technology, settlements will remain a crucial aspect of the evolving payment ecosystem. Remember that simply understanding won’t guarantee great transactions, but it can help you choose the right payment processor and allow you to keep better tabs on finances.

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