What it means
Every time a customer pays by card, a trade is made on an exchange or money is sent across a border, someone is paid for handling it. Payment processors, banks, card networks, brokers and marketplaces each charge for their part of the service.
The charge can be small on a single transaction, but it adds up across thousands. A common structure for card payments is a percentage of the sale plus a small fixed amount.
Marketplaces may charge a commission on every sale, brokers charge per trade or per share, and money transfer services add fees and a margin on the exchange rate. The structure is set out in the merchant agreement or fee schedule.
For finance teams, the key is to measure fees as a percentage of sales. A fee of 3.5% looks modest until it is compared with a net profit margin of 8%, when it takes a large bite.
Fees also differ by payment method, so the mix of customers paying by card, bank transfer or digital wallet can change the average cost. Accounting treatment is generally to record transaction fees as an expense, often under a heading such as payment processing costs or bank charges.
Businesses should reconcile the amounts deducted by the processor against the sales reported, because settlements are often paid net of fees and can hide the true revenue figure. Controlling fees is a regular task.
Companies negotiate rates when volumes grow, steer customers to cheaper payment methods, and check for hidden extras such as refund fees, chargeback fees and currency conversion charges. A small saving in percentage terms can be worth a great deal at scale.
Some fees are fixed and others are variable, which matters for pricing. Low-priced items suffer most from fixed amounts, because $0.30 on a $5 sale is far more than $0.30 on a $500 sale.
In practice
Real-world examples
Example 1
An online shop sells handmade candles at $20 each. The processor charges 2.9% plus $0.30, so each sale costs $0.88 in fees, and the owner raises the price slightly to protect her margin. She also offers a small discount for bank transfers, which cost her far less to receive.
Example 2
A freelance consultant invoices international clients and receives payment through a transfer service. She compares the fees of three providers and finds that the cheapest saves her almost $600 a year.
Example 3
A retail investor trades shares through a broker that charges a flat $5 per trade. She decides to make fewer, larger trades, because a $5 fee on a $200 purchase is 2.5% of the amount.
Think of it
Transaction fees are like the toll charges you pay on a motorway. Even though the toll booth only takes a few coins or pounds per car, making multiple trips adds up and eats into the fuel money you set aside for your journey.
Formula
Calculation
Fee per transaction = (Transaction value x Percentage rate) + Fixed fee
Effective fee rate = Total fees / Total sales x 100
A shop accepts card payments with a fee of 2.9% plus $0.30 per transaction. On a $50 sale the fee = 50 x 0.029 + 0.30 = 1.45 + 0.30 = $1.75. In a month the shop processes 4,000 such transactions, so total sales = 4,000 x 50 = $200,000 and total fees = 4,000 x 1.75 = $7,000. The effective fee rate = 7,000 / 200,000 = 0.035, or 3.5%.Case study
Seen in the real world
Sandalwood Cafe Group is an illustrative, fictional chain with 12 outlets. Its finance manager noticed that payment fees had grown to $96,000 a year as more customers paid by card.
She reviewed the statements and found that the group paid a higher rate on some card types than the agreement stated. She also saw that refund and chargeback fees had not been tracked at all.
After a renegotiation and a small incentive for customers to use cheaper payment methods, the effective rate fell from 2.8% to 2.4%. In this illustrative story, the saving of roughly $13,700 a year more than paid for the time spent reviewing the contracts. The finance manager now reviews the processor statements every quarter, comparing the rates charged with the signed agreement, and reports any difference to the group director.
Watch out
Common mistakes
- Ignoring fixed per-transaction fees on low-value sales, where they take a much larger share of the price.
- Not reconciling settlements, so fees are hidden inside net deposits and revenue appears lower than it should.
- Accepting the first rate offered without comparing providers or renegotiating as volumes grow.
Questions
People also ask
Who pays the transaction fee, the buyer or the seller?
It depends on the agreement, but in many card payments the merchant pays, and some businesses pass it on through a surcharge where the law allows.
How should transaction fees be recorded in the accounts?
Usually as an expense such as payment processing costs, with the sale recorded at its full gross value.
Can transaction fees be reduced?
Often yes, through volume discounts, better pricing structures, steering customers to cheaper methods and regularly reviewing the contract.