How Refunds Affect Your Merchant Account

Issuing Refunds

When you process a refund for a customer who paid with a credit or debit card, your credit card processor reverses the sale and the customer is credited for the original purchase price. There typically won’t be an additional processing fee to issue the refund, but whether you get your original processing fee back depends on your processor and merchant agreement. This is where interchange credits come in.

Interchange Credits on Refunds

Believe it or not, there’s no requirement that credit card processors return the processing fee on the transaction you refund. If your processor doesn’t return that fee, you lose money on each refund you process. However, even if your processor does return the fees, the interchange refund is actually not the full amount you originally paid. But getting something back is better than nothing and helps mitigate financial loss of processing refunds.

I’ve covered this separately in this article on interchange credits on refunds.

Note: CardFellow members don’t have to worry – our legal agreement with processors requires that they pass interchange credits back to you.

Refunds vs. Chargebacks

It’s important to note that refunds aren’t the same as chargebacks. Refunds are voluntary. You as a business owner choose to give the customer their money back due to the customer’s unhappiness with the transaction or their claim that it was a fraudulent purchase. Refunds have become increasingly common for online sales in particular, where customers don’t have a chance to see or try on items before purchase. They’re also common in industries where customers make purchases to gift to others.

Chargebacks, on the other hand, happen when the customer initiates a dispute with their bank. In this case, they’re unhappy with the transaction but either your business refused to issue a refund, or the customer didn’t try to obtain a refund but went straight to a dispute.

In most cases, the bank will require a customer to work with your business before issuing a chargeback, but if the customer claims fraud the bank might initiate the chargeback immediately.

But it’s the situation where a customer is unhappy and you’re unsure about issuing the refund that causes the most headaches. I’ll get into best practices to minimize refunds later in this article.

Refunds to Avoid Chargebacks

There can be a variety of reasons that you might not want to issue a refund, such as making a personalized item for a specific customer that you won’t be able to sell to others or having a customer attempt to return a worn item or an item past the return period.

It’s up to you to determine when to bite the bullet and issue the refund anyway and when to stand your ground.

Keep in mind that if you refuse to issue a refund, the customer can file a dispute with their bank, who can issue a chargeback. That process is known to be somewhat more customer-friendly than business-friendly. You’ll need to gather evidence of the legitimacy of the transaction and proof of how it doesn’t meet your refund policy to fight the chargeback. Even with evidence a bank can rule against you.

Unlike refunds, a chargeback dings you in more than just the loss of the money: it counts toward your “chargeback ratio” or the number of chargebacks that are considered acceptable. Processors typically require your chargeback rate to 1% or less of your total transactions. If you exceed that, you run the risk of having your merchant account frozen or closed without warning.

In some cases, proactively offering the refund instead of allowing it to progress to a chargeback is a strategic business move. However, you’ll need to consider the total amount of the lost sale, the ability to resell the merchandise, and other factors specific to your business to determine if or when that’s the right strategy.

Is there such a thing as too many refunds?

There can be. There isn’t a specific threshold for refunds like there is for chargebacks, but it can still cause concern for your processor.

If you issue a lot of refunds, or if your refund rate is increasing, it can indicate issues with your product or show poor customer satisfaction, which can worry processors. They may be concerned about your funding availability to issue the refunds. Additionally, increasing refund rates can sometimes precede increased chargebacks.

Refunds and Your Cash Flow

As a small business owner, you’re probably always keeping an eye on cash flow. How do refunds affect it? The main thing to remember is that they don’t process instantly. It can take a few days for the funds to be pulled from your account and deposited to the customer’s account. But it will come out of your settlement account, causing a dip in cash flow.

Most of the time, for a few refunds here and there, the impact should be minimal. But if you process several refunds in a short time period, be sure to keep a closer eye on cash flow to avoid any unexpected surprises.

Refund Best Practices

So how do you avoid having to provide excessive refunds? There are several steps you can take:

Be honest about your products and services, especially if you sell online where customers can’t see items firsthand. Don’t embellish features or post “stock” photos that don’t match the quality or condition of the items you sell.

Have a clear return policy posted prominently in your store or on your website. Consider the timeframe for returns and how flexible you can be. A business selling holiday decor may have a shorter return window so that customers don’t use the item and then attempt to return it after the season is over. But a business selling electronics may have a longer window as long as the package is unopened, for example. Be willing to take situation-specific factors into account when deciding whether to issue a refund that may be outside of the standard policy.

Process refunds immediately when you do grant them. Your customers will want to see their refund as soon as possible, and it will help you avoid the risk of the customer escalating it to a chargeback.

Track items most frequently returned to help determine if you need to replace that product in your line. Many inventory management systems can help you identify your most returned items so you can make informed decisions and improve customer satisfaction.

A Note on Custom Work

One area that causes frustration for business owners is custom work. If you run a shop that personalizes items for a specific customer, makes garments or products to a customer’s measurements or specifications, or otherwise provides custom work, it’s particularly challenging when the customer wants a refund. Many such businesses have “no refund” policies, but beware that in those cases, customers often pursue chargebacks. However, custom items are one area where businesses may find it worthwhile to fight the chargeback. You’ll need to consider whether you will likely be able to sell the item to another customer and the total cost of the item. If you’re unlikely to be able to sell it to another customer and the item is a higher value (several hundred dollars or more) then it’s worth your time to fight the chargeback.

Try to protect yourself against the need for the refund early: draft a contract with the customer, detailing what you will provide. Include drawings or pictures if applicable, and be specific with what you will deliver. Provide progress updates and communicate with the customer during production, checking in for any changes and that they are happy with the progress. Get documentation of the customer’s approval in writing. Within reason, provide the customer with an opportunity to have adjustments made after delivery if something doesn’t fit as expected or doesn’t match their expectations.

At the end of the day, it’s impossible to completely avoid refunds. But you can minimize how often they happen by working with your customers and managing expectations. You’ll keep more of your money AND keep your merchant account in good standing by taking an active role in managing your refunds.