Merchant account reserves refer to a portion of funds held back by a payment processor or acquiring bank from a merchant’s incoming transactions. The funds are set aside as a security measure to cover potential chargebacks or refunds, and they can range from a percentage of every transaction to a fixed amount. The reserve is usually released after a specified period or when certain conditions are met, such as a decrease in a chargeback or refund rates. Merchant account reserves can impact a merchant’s cash flow and should be considered when setting up payment processing services.
Types of Merchant Account Reserves and How They Work
Merchant account reserves are a crucial aspect of payment processing services that can help protect merchants and payment processors against potential losses due to chargebacks, refunds, or other issues. There are different merchant account reserves, each with its characteristics and requirements. Here are some of the most common types of merchant account reserves and how they work:
Types of Merchant Account Reserves
I. Rolling Reserves
Rolling reserves are the most common type of merchant account reserve, with a portion of each transaction being withheld and held in a separate account, usually for 90 days. This reserve protects payment processors from unexpected losses due to chargebacks or refunds. Chargebacks occur when a customer disputes a transaction and requests a refund from their bank. If the dispute is successful, the payment processor is responsible for refunding the customer, which can result in a loss for the payment processor and the merchant.
According to a study by Chargebacks911, chargebacks cost e-commerce businesses $40 billion in 2020, with the average chargeback amounting to $136. Rolling reserves help protect merchants against these unexpected losses. The amount held in reserve is usually a percentage of each transaction, with the percentage varying depending on the industry and the risk associated with the business.
How Rolling Reserves Work
Rolling reserves work by holding a percentage of each transaction in a separate account for a set period, usually 90 days. After 90 days, the reserve is released back to the merchant. However, the reserve amount may be increased or extended if the merchant experiences unusually high chargebacks or refunds during this period. This ensures that the payment processor has sufficient funds to cover any losses.
According to a study by the Merchant Risk Council, chargeback rates for e-commerce businesses increased by 25% in 2020. This highlights the importance of rolling reserves, as they help protect merchants from unexpected losses due to chargebacks.
Pros and Cons of Rolling Reserves
The primary benefit of rolling reserves is that they protect merchants against unexpected losses due to chargebacks or refunds. They also provide payment processors with a sense of security and ensure that they have sufficient funds to cover any losses. However, rolling reserves can negatively impact business cash flow and profitability, reducing the money available immediately. According to a study by Visa, rolling reserves can decrease a business’s cash flow by up to 50%.
Examples of Industries that Commonly Use Rolling Reserves
Rolling reserves are commonly used in high-risk industries with a high risk of chargebacks, such as travel and ticketing. According to a study by Sift, the travel industry experienced a 25% increase in chargebacks in 2020, with the average chargeback amounting to $317. This highlights the importance of rolling reserves in protecting merchants from unexpected losses.
II. Upfront Reserves
Upfront reserves are a lump sum of reserve funds before processing transactions. This type of reserve is usually required for new or high-risk businesses, such as those in the e-commerce and direct marketing industries. According to a study by the Small Business Administration, 20% of small businesses fail within their first year, highlighting the importance of upfront reserves.
How Upfront Reserves Work
Upfront reserves work by requiring a predetermined amount of funds to be held as a security deposit before any transactions are processed, usually for 180 days. After 180 days, the reserve is released back to the merchant. However, the reserve amount may be increased or extended if the merchant experiences many chargebacks or refunds during this period. Upfront reserves provide payment processors with security and help mitigate the risk of chargebacks or refunds.
Pros and Cons of Upfront Reserves
The primary benefit of upfront reserves is that they provide a sense of security for payment processors and help mitigate the risk of chargebacks or refunds. They also help new or high-risk businesses establish credibility with payment processors. However, upfront reserves can be a financial burden for businesses that need immediate access to funds, as a predetermined amount of funds is held in reserve. This can negatively impact cash flow and profitability.
Examples of Industries that Commonly Use Upfront Reserves
Upfront reserves are commonly required for new or high-risk businesses, such as those in the e-commerce and direct marketing industries. These businesses may have limited operating histories or be selling products more susceptible to chargebacks or refunds. According to a study by the National Retail Federation, online return rates in the retail industry increased by 70% in 2020 due to the COVID-19 pandemic. This highlights the importance of upfront reserves in protecting payment processors and merchants from potential losses.
III. Minimum Reserves
Minimum reserves are a minimum amount of funds held in reserve at all times, either as a percentage of sales or a fixed amount. This type of reserve ensures that payment processors have a consistent level of security and provides a buffer against unexpected losses.
How Minimum Reserves Work
Minimum reserves require a predetermined amount of funds to be held in reserve at all times, either as a percentage of sales or a fixed amount. Unlike rolling and upfront reserves, this reserve is not released to the merchant after a set period. Minimum reserves provide payment processors with a consistent level of security and help mitigate the risk of unexpected losses.
Pros and Cons of Minimum Reserves
The primary benefit of minimum reserves is that they ensure consistent security for payment processors and provide a buffer against unexpected losses. However, minimum reserves can be challenging for businesses with irregular sales volumes, as they may not have sufficient funds to cover the reserve requirement. This can negatively impact cash flow and profitability.
Examples of Industries that Commonly Use Minimum Reserves
Minimum reserves are commonly required in industries with consistent sales volumes, such as retail and hospitality. These industries have more predictable revenue streams, which allows for easier forecasting and planning of reserve requirements. According to a study by the National Restaurant Association, the restaurant industry experienced a 65% decrease in sales in 2020 due to the COVID-19 pandemic. Minimum reserves help protect payment processors and merchants in these industries from potential losses.
How to Manage Merchant Account Reserves
Managing merchant account reserves is crucial for businesses to ensure sufficient funds for operations and growth. Here are some tips for effectively managing merchant account reserves:
Understand Reserve Release Schedules- It’s important to understand when reserves will be released to accurately predict cash flow and plan for business expenses.
Maintain Open Communication with Payment Processors – Clear communication with payment processors can help businesses understand reserve requirements and release schedules.
Monitor Chargeback and Refund Rates – Monitoring chargeback and refund rates can help businesses identify potential issues early and take corrective action.
Final Thoughts
Merchant account reserves are essential to payment processing that can affect business cash flow and profitability. Understanding the different types of merchant account reserves – rolling, upfront, and minimum – and how they work is crucial for businesses to effectively manage their reserves. By following the tips for managing merchant account reserves, businesses can ensure sufficient funds for operations and growth while protecting payment processors from potential losses.
