Basis Point Calculation

Basis Point Calculation

Credit card processing services come with different fees. Some are charged per transaction, some are assessed monthly, and some are percentage-based. Every company is different. The better you understand these charges, the better you will be able to determine which credit card processing service is best for your business needs.

When it comes to credit card processing services, one of the most important terms you will hear is “basis point.” Whilst basis points can have several definitions, in terms of credit card processing, they are used to describe differences in fee structures. In this post, we will go over why you should care about basis points, how to calculate them, and how they apply to your card processing statements.

What Does Basis Point Mean, Exactly?

A basis point is a fraction of a percentage point – 1/100th to be precise. One basis point is 0.01 percent or, if you were writing a single basis point as a decimal, it would look like this: 0.0001.

So, if you were charged a fee of 100 basis points on £5,000, that would result in a charge of £50. The 100 basis points could be written as 1 percent or 0.01. (Here is a handy)

What’s the Point in Basis Points?

Glad you asked! Often abbreviated as “BPS,” basis points are sometimes called “bips.” They pop up in all sorts of financial calculations that require fractions of percentages, such as bond yields and interest rates. In credit card processing, bps normally refers to the markup that credit card processors charge.

Basis points have an important function. They simplify things.

It works like this. If a company says that it will charge you 5 percent of the transaction amount to process a credit card payment but that fee is 5 percent higher when the total amount charged is less than £20, what is the fee? Does processing a smaller transaction add on 5 percent of 5 percent, making it 5.25 percent or does it bring the total charge to 10 percent (5 percent + 5 percent)? It isn’t exactly clear. However, if the processing company says that it charges an increase of 500 basis points, you know that the total charge would be 10 percent (5 percent + 500bps).

Sure. You could also say 5 percentage points instead of 500 basis points and sometimes companies will, but it can be confusing to use the word “percentage” so often. As such, most will explain their fees in terms bps instead.

Credit Card Processing and Basis Points

You will usually see basis points on interchange plus pricing models.

With this type of credit card processing model, you are charged a per-transaction fee as well as interchange fees and a small markup to those amounts.

Credit card companies charge interchange fees when money is transferred from acquiring bank to issuing bank. Visa calls them “interchange reimbursement fees”.

Without going into too much detail, you as the merchant have to pay a percentage of the transaction amount to the credit card company that issued the payment card used in the transaction, such as American Express or Visa.

In this way, Visa (or whomever) gets a little cut because your customer used a payment card that credit card company issued or endorsed. Interchange fees are charged on both bank card and credit card transactions. According to DUE, “the fee was put in place in order to cover handling costs, fraud, bad debt costs, and the risk of approving the transaction.” Interchange fees may vary depending on the credit card company in question. They also change periodically.

If your credit card processor uses an interchange-plus pricing model, you will be asked to pay a transaction fee plus the interchange fee to you as well as a markup. For instance, you could be asked to pay £0.30 + interchange + 50 basis points per transaction, which would be the interchange rate plus 0.5 percent + £0.30.

The Importance of a Bip

When it comes to evaluating credit card processing services, every “bip” counts.

Let’s say the interchange rate for a given credit card company is 2.0 percent. Your credit card processor charges you interchange + 20 basis points + £0.20 per transaction (0.022 percent + £0.20). If your average transaction is £10, you will have to pay (£10 x 0.022 percent) + £0.20, or £0.42.

These fees are deducted from your transaction, so you will net £9.58 from our example.

Okay. Now, let’s say that a new credit card processor offers you a deal. It will charge you just 2.0 percent per transaction including interchange fees but the transaction fee will be set at £0.30 per transaction. Should you do it?

Using your average transaction amount of £10, your cost would be £10 x 2.0 percent plus £0.30, or £0.50 per transaction – that’s £0.08 more than you are currently paying. If your average number of transactions processed each month is 1,000, you would be paying £80 more per month in credit card processing service fees than what is necessary.

But, that’s just one scenario.

Now, let’s say your average transaction amount is £100.

 AB
Transaction£100£100
Processing Rate2.0 percent + 20bps 2.0 percent
Processing Fee£0.20 £0.30
Total Fee£2.40 £2.30

In this scenario, going with the second credit card processor is the better choice. It saves you £0.10 per transaction. If you have 1,000 transactions per month, that’s an extra £100 in your pocket.

Conclusion

Basis points are an important part of understanding your credit card processor’s service fees. Take the time to carefully evaluate what the company is offering and how it would work for your specific business needs before making a decision.