Every time you accept a credit card payment, you’ll be paying a processing fee. Unfortunately, these fees aren’t always straightforward, which is why small business owners rely on the effective rate to evaluate the charges they accumulate each month.
In this guide, we’ll help you get a better handle on the effective rate, helping you learn to calculate your effective rate so you can evaluate your merchant processing solutions.
What Is an Effective Rate?
Your effective rate is simply the price you pay for credit card processing. Your effective rate will include all of your non-negotiable processing fees, as well as any fees assessed by your provider.
In other words, your effective rate accounts for the average cost it takes to process a single credit card transaction expressed as a percentage of the total sale.
Effective Rate vs. Interchange Fees
Why can’t you simply look at the interchange fees when you’re evaluating your merchant processor? These fees are rarely constant.
While your provider fees typically stay the same, the interchange rate can vary widely depending on the type of transaction (eCommerce vs. retail), as well as the type of cards that are used.
A reward card, for example, will cost more to process than other kinds of cards, even if they’re from the same issuer.
This level of variation makes it important to use the effective rate, which will provide an average of these changing fees. Considering small businesses spent $116 billion in processing fees in 2019 alone, lowering this rate can dramatically impact your profitability.
Why You Need to Know Your Effective Rate
Your effective rate will provide the most straightforward and accurate way to evaluate payment processors. This comes in handy in at least two ways.
First, your payment processor likely advertised a low rate when you signed up for their services. But it’s possible you’re paying a higher effective rate than was originally advertised.
Unfortunately, most businesses will never match the “ideal” ratings offered by their provider, but major gaps in the effective rate can show if you’re being overcharged.
Secondly, the effective rates can help you to compare competing payment processors, allowing you to find a solution that fits your business and helps you accept credit card payments in a more cost-effective way.
How Do You Calculate an Effective Rate in Credit Card Processing?
Your effective rate can be calculated quite simply, using the following formula:
Effective rate = (total credit card processing fees / total amount processed) X 100
We’ll walk you through each step of the calculation:
Determine Your Total Credit Card Processing Fees
First, you need to determine the total amount you’re paying in credit card processing fees. This can take a little bit of time since you’ll find these fees in the line items on your statement.
Then, make sure to add in any additional fees, such as monthly charges, processing fees, or any other fees that are reflected on your statement. It’s important to include these figures since this will give you a more accurate picture of what you’re paying when compared to just looking at your sales data.
Divide By the Total Amount Processed
Once you have this number, you’ll divide it by the total amount of money you processed through credit card transactions. This will give you the ratio of the processing fees to the total amount you brought in.
For example, imagine your business brought in $10,000 in credit card transactions last month, but you paid $300 in interchange fees, as well as another $50 for a monthly processing fee.
You would add the $300 and $50 fees together to get $350, then divide this by $10,000. The result is 0.035.
Multiply By 100 to Get Your Percentage
Finally, multiply this decimal by 100% to reach your final percentage. In our above example, the final effective rate would be 3.5%.
Again, this number provides the average rate you’re paying for each credit card transaction, which means that this is the rate you can expect to pay for all credit card sales that occur in your business.
What Is a Good Effective Rate?
This isn’t as straightforward as it may seem, because the rate can vary based on a variety of factors.
What can cause your effective rate to rise?
- Performing multiple, small transactions (e.g., restaurants).
- Processing transactions online vs. in-person.
- Doing business internationally.
- Operating a high-risk business.
- Various card types.
But another possibility, of course, is that your processor’s markup is simply too high.
Once you determine your effective rate, you’ll be in a better position to evaluate your current processing service and compare rates of competing processors should you decide to look elsewhere.
Let Finical Change the Way You Get Paid
Finical helps small business owners accept all forms of payment, from credit cards to Apple Pay and other forms of contactless payment. Best of all, we provide resources to help you minimize your credit card processing fees.
To learn more about what Finical can offer your business, simply contact us through our website.