• Ashwin Nazareth

The Importance of Refunding Transactions to Their Source

Imagine you've made a new year's resolution to monitor your health better (for real this time!). So you head to your neighborhood health supplies store to purchase a new blood pressure monitor (adding to the assortment of other health gadgets you have in a drawer, collecting dust from previous new year resolutions). You pick out the best model available which comes up to $200, head over to the checkout, and pay by card. Excited to get started on your brand new self, you rush home and plug the machine in only to find out that it's completely dead. You're furious, back in the car again, and storming into the store exclaiming "I want a refund". The cashier calls the manager out who says "I'm so sorry, I don't know how to cancel the card transaction. Can I just refund you in cash?".


Several things are going wrong in the scenario above, but the focus of today's article will be the fact that the store opted to go with a cash refund on a credit card transaction, and why as far as you can help it, you should never do this.


Firstly, why would I even want to issue a refund?

Alright, let's dive into the issue of why refunds are a necessary evil in the first place. Oftentimes, consumer protection laws don't allow a business to just shift responsibility for a defective transaction or product to the bank or the manufacturer. They are required to first do something to remedy a bad situation when dealing with a customer complaint. Here are the two main causes of refunds:


  • Processing Errors - More often than not the issues that drive refunds, especially in the online payment space is a payment failure, sometimes called a timeout. This is when the funds were deducted from the buyer's card, but the network was so slow that the seller's side 'stopped listening' for confirmation and canceled the order entirely. However, the money will end up being sent to the seller's account later during the settlement process, but they may not realize it.


  • Customer Complaints - This is when there's something wrong with the order itself, either because of a failed delivery or the quality of the product itself, like in our example above. In this case, as a seller, you may want to issue a partial refund or a full refund. Refunds are very rarely for more than the value of the original transaction, and doing so will require the prior approval of your merchant acquirer.


Are there different ways to complete a refund?

Depending on how long ago the transaction was made, yes there are several ways to complete a refund to the buyer's card:


  • Void Authorization - This is when a payment has been made but not yet settled (usually for same-day refunds) where the seller can just 'release' whatever funds were put on hold from the buyer's credit limit, with no money actually changing hands.


  • Normal Refund - These are the most common type of refund where a seller 'sends back the money' from their account to their buyer's credit card account. The transactions are tied together using the original transaction numbers which will make it clear to both sides (the seller and the buyer) that the loop has been closed.


  • Detached Credit - These are 'free-floating' refunds in the sense that they aren't tied back to the original transaction number. This is required because you as a seller just switched to a new merchant acquirer, or a buyer has switched to a new card company and doesn't have their old card anymore.


Now I know the what, tell me about the why.

Simple, because it's a good idea to issue your buyer a refund to the exact same source as the money came from. Cash to cash, bank transfer to bank transfer, and most definitely credit card back to the same credit card. Here's a more detailed explanation of why:


  • Chargeback avoidance - the credit card association rules are mainly set up to ensure that most 'frivolous' chargebacks can be avoided, for example with transactions you have already refunded. Most good merchant acquirers have some form of automated chargeback defense to do the same. This closes the liability loop for you as a seller, causing fewer interruptions to your day to day operations.


  • Although increasingly rare, there is a potential for you to get your transaction processing fee returned when you refund to the original funding source. This is completely dependent on your acquirer's billing practices and if you find one that does this, it's a good idea to hang on to them so you won't have to write off the original processing fees each time.


  • Avoid money-laundering inquiries or allegations of your store offering 'cash advances'. This is where some merchants operate the objectionable business of charging customers cards and giving them the value in cash, minus a service fee. You can see how similar this would look to the completely legitimate actions in our earlier scenario with the faulty blood pressure monitor. The review process to clear such an allegation would be tedious and may cost you the ability to process card payments and is best avoided at all costs.


OK, I'm convinced. How do I set myself up for this?

The first and easiest bit of advice would be to always keep some money in your merchant account for refunds. You should be able to tell by your past number of refunds how much to set aside, but if you're brand new, it's fine to start with 10% of your daily revenue. there's nothing worse than wanting to perform a card refund but not having enough balance. Try picking a merchant acquirer who allows you to easily top up your merchant account using a backup funding source like a corporate credit card or a bank account in case you fall short.


Second, ensure that you have a store policy where you only refund to the original funding source and display it prominently near your checkout counter or on your checkout page. This is to stop customers (or potential criminals) from demanding otherwise and increasing the amount of paperwork you have to file to defend against fraudulent chargebacks. On that note, it's another best practice to file all refund documentation together with the original transaction slips in case of a chargeback.


Finally, get your store a system that tallies all your successful orders against payments received. Have it flag any that mismatch and immediately refund any excess payments (remember timeouts?). If you make it part of your daily activities like clearing the cash register and closing the settlement on the card payments, you'll thank yourself for it in the long run.


This is all too complicated, I just want to sell things!

Sure, all this can be a little bit overwhelming but it just takes time and practice for it to become second nature to you and your team. Reach out to us at Dicorm to help you set up a process and store policies that make sense for both you and your customers. We'll take care of the setup and training for your team and leave you to do what you do best - growing your business.


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