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How Recurring Payments Work for Small Business Owners

How do recurring payments work?

BarkBox. Birchbox. BoozBox. Bean Box. Once upon a time, recurring payments were limited to rent and utilities. Now, if you can think of a noun, you probably can get it in a box. Subscription service companies and companies like Amazon, who promote a subscription service model, operate on a recurring payment model.

The increase in recurring payments alongside subscriptions is good news for small businesses. That’s because customers are increasingly comfortable authorizing recurring payments for everything from gym memberships to software licensing fees, which cuts down on payment processing labor and can increase customer retention and satisfaction. Accepting recurring payments can also improve the accuracy of cash flow projections and help your customers make payments on time.

What is a recurring payment?

A recurring payment is any type of payment set up to process periodically without requiring additional action on the part of the customer or paying party. Payments for subscription services, utilities, and memberships all frequently use a recurring payment system. Payment plans, which allow customers to split up large purchases over a period of time, are also a type of recurring payment. Recurring payments are also sometimes referred to as automatic payments.

Recurring payments can be either fixed, meaning the payment amount is the same every time, or variable, meaning the payment amount may change based on usage. Subscription services (such as a digital subscription to The New York Times or a quarterly vitamin delivery service) typically have fixed fees, as do memberships (like a boxing gym membership or membership in the Cloud Appreciation Society). Some recurring utility payments (like garbage and recycling pickup) are also fixed, while other utilities like water and electricity bills are calculated based on usage.

How do recurring payments work?

To accept and process recurring payments, businesses must have both a payment processor (also known as a payment service provider) and a merchant account. A merchant account is a specific type of business bank account that is set up to accept recurring payments.

Here’s an overview of how a recurring payment system using a payment card works:

  • A customer purchases goods or services and elects a recurring payment.
  • The customer authorizes the payment details. This includes the terms and conditions, payment amount, payment schedule, and payment end date, if applicable.
  • The customer submits their payment information—in this case, a credit or debit card number—through the payment gateway and agrees to have the payment information saved.
  • The payment processor receives the information through the payment gateway and alerts the customer’s credit card company, the customer’s bank, and the issuing bank.
  • The customer’s bank approves the transaction, and money is transferred to the merchant account.
  • Funds are transferred from the merchant account to the business’s bank account.
  • The process repeats on a pre-determined schedule, with the payment processor initiating each transaction and providing the customer with an invoice.

Recurring payment methods typically include payment cards—either credit or debit—and ACH debit. Some payment processors also offer recurring invoicing—but in this case, the customer must take action to complete the payment. Although recurring invoicing doesn’t offer the same level of predictability as automated payments do, it can still be a time-saving option if your customer won’t agree to a recurring payment model or if their preferred payment method (such as paper check or cash) can’t be automated.

What are the advantages of recurring payments?

  • Efficient for both customer and merchant
  • Eliminates the risk of late or missed payments
  • Establishes trust between customer and merchant

Accepting recurring payments can save time and improve customer retention, customer relationships, and cash flow prediction accuracy. Small business owners can also benefit from setting up recurring bill payments, which reduce administrative burden and ensures bills are paid on time.

1. Efficient for both customer and merchant

Recurring payment systems are efficient for both businesses and customers. Your payment processor can automate invoicing (known as recurring billing) and automatically initiate an ACH debit or a credit card charge, saving time and reducing the potential for human error. Accepting recurring payments can also make it easier to anticipate financial liquidity.

For your customers, automating payments can eliminate the hassle of administrative tasks like ordering more coffee filters or opening and processing heating bills. The same benefits also apply to your business: setting up automated withdrawals for utilities and other recurring bills can save time.

2. Eliminates the risk of late or missed payments

Missed payments are a hassle for both customers and merchants. On the merchant side, businesses must follow up with customers to collect payment. This takes time and may require more than one attempt. Missed payments can also make your projections for cash on hand inaccurate.

On the customer side, missing a payment can result in a late fee. And a missed utility payment can damage your credit, or even result in the lights going out in your offices. Recurring payments ensure that you never miss a payment or incur a late fee.

3. Establishes trust between customer and merchant

Recurring payments can help in building trust with your customers and improving customer retention. Customers appreciate the ease of payments, the ability to make large purchases on a payment plan, and the convenience of receiving goods and services on a set schedule.

Recurring payments also reduce the barrier to purchase. While one-time payments require a customer to act to make a purchase, recurring payments require a customer to act to avoid making a purchase. Customers are busy, and recurring payments can help prevent a customer’s hectic schedule from inhibiting a purchase.

What are the disadvantages of recurring payments?

Recurring payments are popular with customers and merchants, but they don’t come without risk. Disadvantages of recurring payment systems include increased transaction fees and the potential for errors or fraud.

1. Fraud, errors, and accidental charges

Recurring payments present an increased fraud risk because customers don’t need to actively approve individual charges, and payment card information can be stolen. Errors are also a risk. If your electricity company accidentally overcharges your business (or charges you twice), you won’t notice the mistake until you review bank account withdrawals and credit card statements. During a one-time transaction, you might notice the error quicker.

2. Higher transaction rates for merchants

Increased risk can also come with increased fees, and payment processors typically charge merchants higher transaction rates for recurring payments than for one-time transactions. These rates vary by payment processor, but frequently range from 3% to 3.5% of total transaction cost, plus a flat per-transaction fee.

Recurring payments FAQ

What are examples of recurring payments?

Subscription services, online bill payments, and memberships are all types of recurring payments. Examples include: A monthly charge for a membership at a boxing gym An automated ACH debit for the heating bill at your office A recurring credit card charge for a quarterly delivery of Atlantic cod An annual donation to the World Wildlife Fund A payment plan for a Givenchy bag

What is the difference between a one-time payment and a recurring payment?

When making a one-time payment, a customer authorizes a single charge for a good or service. If the customer wishes to make another purchase, they need to authorize a separate transaction. When initiating a recurring transaction, a customer makes a singular authorization for repeat payments. Recurring payments are set up on a predetermined schedule and can either have a set end date or recur until the customer manually ends the recurring payments—by canceling their subscription, for example.

Are recurring payments the same as automatic payments?

Recurring payments are also frequently referred to as automatic payments. Some payment processors draw a distinction between recurring payments and automatic payments, classifying fixed-amount payments as recurring payments and variable-amount payments as automatic payments. This terminology varies between providers. Providing clear terms and conditions (and, on the receiving end, reading them) can help you understand whether your payment amount can change.

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