Understanding your effective rate for credit card processing is crucial because it helps you evaluate the true cost of accepting card payments. It goes beyond the visible fees and gives you a more accurate picture of what you’re paying to process transactions. Here’s a breakdown of what the effective rate is, how to calculate it, and why it’s important to your business:
What is the Effective Rate?
The effective rate is the total cost of credit card processing fees expressed as a percentage of your total sales volume. This includes all associated costs, such as:
- Transaction fees (fixed fees per transaction or percentage-based fees)
- Monthly fees (service fees, account maintenance, etc.)
- Other hidden fees (chargeback fees, setup fees, etc.)
How to Calculate the Effective Rate
To calculate the effective rate, you need to total all the fees a business pays for credit card processing over a specific period (e.g., a month), then divide that amount by the total sales processed in that period.
Here’s the formula:
Effective Rate = (Total Credit Card Sales /Total Fees) ×100
- Total Fees: If your total fees for the month are $1,000.
- Total Credit Card Sales: If your total credit card sales for the month are $50,000.
For example:
Effective Rate = (50,0001,000) × 100 = 2%
Why the Effective Rate is Important
- Cost Management: Understanding your effective rate helps you assess whether you’re paying too much for card processing. A high effective rate might indicate you’re using an expensive payment processor or paying unnecessary fees.
- Comparison Shopping: Once you know your current effective rate, you can compare it with other providers. This allows you to shop around and potentially switch to a more cost-effective processor, saving money in the long run.
- Financial Planning and Pricing: Knowing your effective rate helps you build accurate pricing models and forecasts. It ensures you’re factoring in all costs of accepting payments and can set prices that cover those costs while maintaining profitability.
- Negotiation Leverage: If you have a high sales volume, you may be able to negotiate lower processing fees with your payment provider. Knowing your effective rate and understanding how it compares to industry averages gives you the information needed to request a better deal.
- Identifying Hidden Costs: Your effective rate consolidates all fees, including those that might not be immediately apparent, like monthly minimums or extra service charges. By calculating your effective rate, you can identify areas where you may be overpaying.
Common Factors Affecting Your Effective Rate
- Transaction Volume: Higher transaction volumes can often lead to lower rates because processors typically offer volume-based pricing.
- Transaction Types: Swiped or chip transactions are usually cheaper than keyed-in transactions, and international transactions may also carry higher fees.
- Pricing Structure: Different processors offer different pricing models, such as flat-rate, interchange-plus, or tiered pricing. Each structure can affect your effective rate.
- Additional Services: Some providers offer add-ons like fraud protection, reporting tools, and customer service, which could increase your costs.
Optimizing the Effective Rate
Negotiation: Businesses can negotiate fees with processors, especially if they process a large volume of transactions.
Payment Methods: Encouraging customers to use lower-cost payment methods, like debit cards, can reduce processing fees.
Switching Processors: If a business identifies that its current processor’s fees are too high, it may be worth exploring alternative processors.
Conclusion
By regularly calculating and monitoring your effective rate, you can better understand your business’s payment processing expenses, identify opportunities to reduce costs, and make more informed decisions about your payment processing providers. Understanding this rate is crucial for maintaining profitability and ensuring your business isn’t overpaying for credit card processing services.
Benchmark offers a complimentary, no-obligation rate analysis for PSIvet members. You may take advantage of this service as often as you would like, and every 6 to 12 months is recommended. Contact Us for a Free Rate Analysis today.