Understanding Effective Rates

First off, if you own a business, most likely, at one time or another, you’ve been thoroughly confused when your merchant service rep or company talking to you about pricing, pricing structures, or what you should pay.  I would suggest taking everything they’ve said and everything you’ve heard to this point and just forget about it.  Let’s start fresh.

There is only one number or rate that you should be concerned with and that’s your overall effective rate.  That is the the amount you actually pay in total to your processor at the end of the month.  Anyone that was able to make it through 5th grade math can garner a effective rate given 2 numbers.

What were you charged for any given month?  (We’ll make that ‘A‘)

How much credit card business did you do in said month? (We’ll call that ‘B‘)

Take ‘A‘ and divide by ‘B‘ and you get an effective rate.  For the math geniuses:

A / B = C

If you were charged $1,245 in fees and processed $53,268, your effective rate is 2.33%.   This is the only number you should be concerned with!

Why, you ask…Because the way every merchant rep out there makes money is on the ‘fluff’.   We’re taught to draw your attention away from what really matters to get you to focus on the areas that we tell you are important.   The effective rate makes things like ‘Teaser Rates’ irrelevant.

Here is an example:  I had a nice conversation with a lady that owns a quick serve hamburger stand in California.  She was referred to me by an existing client and had a few needs:  She wanted to save some money on her processing and get a new POS System.  She sent me a few statements from her current processing company for review.  At first glance I could see that she was paying a premium but I had to do some more digging.  My research into her statement showed that her average transaction amount was $13  ($28,756 processed / 2,212 transactions)  and her effective rate was 3.75%.  ($28,756 processed, $1,078 paid in fees)   The $13.00 average ticket plays a big role in the effective rate because for every transaction you process, your processor will charge you 2 things:  A percentage and a transaction fee. The percentage changes depending on the type of card and how the transaction is ran.  (swiped, chip card or hand keyed)

For this particular client, I broke down everything for her about her current statement and sent her an email along with what she might look to pay with my company.  I also offered up a few POS systems that I thought might work for her, sent her some links for her to do some research and then followed up in a day or two.  In my breakdown to her, I was able to get her effective rate down to 3.1%.  I received and email simply stating that she had decided to go with PayPal and that her reason was they simply charge a flat rate of 2.7%.  Wanting her to be completely educated, I jumped on the PayPal website to do some research.  I was able to email her a link to the area that would apply to her business and the associated rates.  On that page it stated 2.7% flat and a $.30 transaction fee per transaction.  What I think happened in this case is she heard 2.7% and that’s all that mattered.  I would classify the 2.7% PayPal offers as a teaser rate as that’s not was she will pay, not even close.

I mention above how the average transaction amount plays a huge role in the effective rate of an account.  If she decides to go with PayPal, and we do some math, her effective rate on that $13 transaction is going to be 5.0%.  Her effective rate will increased by 1.25%.  In money numbers, her fees will increase by $125 for every $10,000 in credit card business she does.

Let me break down how I came to that number:  First, multiply the 2.7% from PayPal by the $13 transaction and you’ll get $.35.  Then add the $.30 cent transaction fee they charge and your total will be $.65.

13 X .027 = .35 + .30 =.65

Take the $.65 and divide it by the transaction amount of $13.00 and you get 5%.

.65 / 13 = .05

Because her transaction fee is so low, that transaction cost of $.30 makes a huge difference.  She is just looking at the 2.7% flat rate and she missed the $.30 they charge to every transaction which ultimately doubles her rate.

Although she may not call me back to handle her processing, she will be calling someone.  My point is simple, as a business owner you should really be concerned with only one number, your effective rate.  Everything else is irrelevant.  Now, PayPal won’t tell her what her effective rate might be, she has to figure it out on her own.

In this particular case, I think she is just missing the transaction fee.  This is not some crazy, smoke and mirrors sales tactic by me, it’s just math, simple math.

Not every business is the same and therefore each business will have a different effective rate.  The top 5 things that have the biggest impact on your effective rate:

  1. Who is your processor
  2. Your average transaction amount
  3. How you accept payment
  4. Location
  5. What cards your clients use to pay

I will explain in detail in a later post exactly how each one of these directly relates to an effective rate and what you can do as a business owner to ensure you aren’t wasting money.

Until next week,

I’m Ed Craft, your credit card guy!

15 years in the business and counting.

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