Merchant Account Effective Rate: The Only One That Matters

Anyone that's had to deal with merchant accounts and credit card processing will tell you that the subject can get pretty confusing. There's a lot to know when looking for new merchant processing services or when you're trying to decipher an account that you already have. You've got to consider discount fees, qualification rates, interchange, authorization fees and more. The list of potential charges seems to go on and on.

The trap that many people fall into is that they get intimidated by the volume and apparent complexity of the different charges associated with merchant processing. Instead of looking at the big picture, they fixate on a single aspect of an account such as the discount rate or the early termination fee. This is understandable but it makes recognizing the total processing costs associated with an account very difficult.

Once you scratch the surface of merchant accounts they aren't that hard figure out. In this article I'll introduce you to an industry concept that will start you down to path to becoming an expert at comparing merchant accounts or accurately forecasting the processing charges for the account that you already have.

Figuring out how much a merchant account will cost your business in processing fees starts with something called the effective rate. The term effective rate is used to refer to the collective percentage of gross sales that a business pays in credit card processing fees.

For example, if a business processes $10,000 in gross credit and debit card sales and its total processing expense is $329.00, the effective rate of this business's merchant account is 3.29%. The qualified discount rate on this account may only be 2.25%, but surcharges and other fees bring the total cost over a full percentage point higher. This example illustrate perfectly how focusing on a single rate when examining a merchant account can prove to be a costly oversight.

The effective rate is the single most important cost factor when you're comparing merchant accounts and, not surprisingly, it's also one of the most elusive to calculate. When shopping for an account the effective rate will show you the least expensive option, and after you begin processing it will allow you to calculate and forecast your total credit card processing expenses.

Before I get into the nitty-gritty of how to calculate the effective rate, I need to clarify an important point. Calculating the effective rate of a merchant account for an existing business is easier and more accurate than calculating the rate for a new business because figures are based on real processing history rather than forecasts and estimates.

That's not to say that a new business should ignore the effective rate of a proposed account. It is still the most important cost factor, but in the case of a new business the effective rate should be interpreted as a conservative estimate.

It's pretty simple to calculate the effective rate for an existing merchant account. All you need to do is figure out the percentage of expenses over gross credit and debit card sales. To do this, divide your gross sales by your total processing costs for a given month and then multiply that number by 100. For example:

$10,000 in sales / $329 in fees * 100 = 3.29%

If the effective rate ends up being substantially greater than your qualified discount rate, it's time to examine your account and make money-saving adjustments. Using the example above, let's say the qualified discount rate for this account is 1.69%. That would mean the effective rate of 3.29% is more than double the qualified discount rate. In a situation like this, the chances are very good that there are a lot of mid and non-qualified surcharges being applied.

If you notice a large discrepancy between the qualified rate and the effective rate of your merchant account, call your provider and inquire how the gap can be closed.

To calculate the effective rate for a new merchant account from existing processing history, apply your business's processing statistics such as the percentage of mid and non-qualified transactions, PIN debit transactions versus signature and so on to the rates and fees of the new account. This will yield a pretty accurate estimate of the cost associated with the new account.

Calculating the effective rate of a merchant account for a new business is a little tougher because of inconsistent buckets, and the lack of processing history from which to judge how a business's transactions will qualify. Nevertheless, making a conservative estimate of an account's effective rate is still vital.

To calculate the effective rate of a merchant account for a business without processing history you will need to estimate a few figures such as the business's average ticket, processing volume, whether a PIN pad will be used to accept online debit transactions and more. The actual methods involved in calculating the effective are pretty involved and beyond the scope of this article. Luckily, these calculations aren't something you should have to worry about.

Any provider that's courting your business should be able to speak with you to gather the information they need to offer you a reasonably accurate effective rate. If they're unable to do this or they don't know what an effective rate is, they're probably not the best candidate for your new merchant account provider.

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