Guide to Payment Types, With Pros and Cons for Each (2024)

What Is a Payment?

Payment is the transfer of money, goods, or services in exchange for goods and services in acceptable proportions that have been previously agreed upon by all parties involved. A payment can be made in the form of services exchanged, cash, check, wire transfer, credit card, debit card, or cryptocurrencies.

Understanding Payments

Today's monetary system allows for payments to be made with currency. Currency, which has simplified the means of economic transactions, provides a convenient medium through which payments can be made, and it can also be easily stored.

Before the widespread use of currency and other payment methods, barter payments were used in which one product or service was exchanged for another. For example, if an egg farmer with a large surplus of eggs wanted milk, the farmer would need to find a dairy farmer who would be willing to take eggs as payment for milk.

In this case, if a suitable dairy farmer weren't found in time, not only would the egg farmer not get the milk, but the eggs would spoil, becoming worthless. Currency, on the other hand, maintains its value over time. However, bartering is still practiced today when companies want to exchange services between one another.

Payments can be the transfer of anything of value or benefit to the parties. Aninvoiceor bill typically precedes a payment. Payees usually get tochoose how they will accept payment. However, somelaws require the payer to accept the country'slegal tenderup to a prescribed limit.Payment in another currency often involves additionalforeign exchangetransaction fees, usually around 2–3% of the total payment being made, but could be quite a bit higher depending on the bank or card issuer and country of purchase.

Types of Payments

Payments are made using various methods. Throughout history, these types of payments have changed and evolved, and new payment methods are likely to appear in the future. Here are the most common types of payments used today.

Credit Cards

Today, credit cards are widely used for purchases and payments. Credit cards work by offering its user a line of where where an individual can draw credit up to a certain limit. When you attempt to use your credit card, your account information is sent to the merchant bank. The merchant bank then receives authorization from the credit card network to process the transaction.

Many businesses accept credit cards, though many that accept cards charge a fee from the merchant that provides the machine and payments infrastructure as well as their financial institution. This fee is often a percentage of the transaction amount and/or a flat fee for each payment.

Debit Cards

Debit cards may look similar to credit cards, but their underlying mechanism is entirely different. When a debit card is used, funds are immediately withdrawn from an individual's account. Instead of having a line of credit that you can pull from in excess of what you have saved, debit card transactions can be declined if you do not have enough money in your account.

Debit cards share many advantages as credit cards, as the small piece of plastic is easy to carry, widely accepted by many merchants, and has varying levels of fraud protection. However, debit cards often have less promotional opportunities and may result in processing fees if you accidently attempt to overdraw your account.

Cash

Cash is still used for many businesses, such as the retail industry. Coffee shops and convenience stores, for example, still accept cash payments. Considering the fees associated with debit and credit cards, many retail small businesses prefer cash payments from their customers. Cash has its own disadvantages, as it can be lost, stolen, or destroyed. Businesses dealing in large transactions must often incur additional expenses to pay for related security measures such as secured transit or fraud detection.

Mobile Phones

The contactless payment technology that has emerged in recent years has made payments easier than ever. The credit or debit card machine—called a point of sale terminal (POS)—can read the customer's banking information through the software application that's installed on the mobile device. Once the phone reads the information from the POS terminal, a signal is generated to inform the customer that the payment has been made.

For mobile payments to work, the payer must have a higher-end mobile device with near-field communication (NFC) capability. The user then needs to set up their mobile wallet to contain their existing card information. The bank that issued your credit card often has to approve the new payment platform, and the payee must have capabilities to accept mobile payment.

Checks

Checks have fallen out of favor over the years due to advancements in technology, allowing payments to be electronically submitted. However, there are instances when checks might be helpful, such as when the seller wants a guaranteed payment. A bank cashier's check or a certified check are two types of checks that banks offer to help sellers receive the money owed from the buyer.

Checks are linked to a payer's bank account. Each check contains your bank's routing number (a nine digit code to identify financial institution) as well as your account number. When a check is written, the payee deposits the check, sending the transaction to a clearing unit. The clearing unit makes the appropriate changes to each party's account.

Electronic Funds Transfers

Wire transfers and ACH payments (Automatic Clearing House) are typically used for larger or more frequent payments in which a check or credit card wouldn't be appropriate. A payment from a manufacturer to a supplier, for example, would typically be done via wire transfer, particularly if it was an international payment. An ACH payment is often used for direct deposits of payroll for a company's employees.

Though both are transfers of electronic funds, ACHs and wire transfers are different. ACHs only work domestically, and often take one or more business days to fully process. Wires are most often processed same day but have location limitations. In addition, ACHs can often be reversed, while wire payments are permanent once the transaction is initiated.

Cryptocurrency

Digital currency or tokens are a more modern approach to facilitating transactions. The premise is simple: one person in possession of digital currency can send coins or tokens to any address on a blockchain. Blockchains with smart contract capabilities can interject logic to automatically withdraw or transfer specific amounts based on underlying conditions.

The widespread use of cryptocurrency is still in its infancy stage, especially when compared with other payment systems above. However, cryptocurrency has the advantage in only needing an Internet connection to facilitate a payment; as long both parties have a digital wallet on the same network, payments can be made.

Special Considerations

The payee may choose tocompromiseon debt andaccept partial payment in lieu of full settlement of theobligation, or it may offer a discount at their discretion. The payee may also impose asurcharge, for example, as in a late payment fee, or for the use of a certain credit card.

Acceptance of payment by the payee extinguishes a debt or other obligation. A creditor cannot unreasonably refuse to accept a payment, but payment can be refused in some circ*mstances, such as on a Sunday or outside banking hours. A payee is usually obligated to acknowledge payment by producing areceiptto the payer, which may be regarded as anendorsem*nt on an account as "paid in full."

Payment Credit Terms and Discounts

Every company that receives payments must set their payment terms. This payment term dictates when payment is due and whether the company offers a discount for early payment.

The most common form of payment term is called "net 30" where a payment is due 30 days from the receipt of the invoice. A company may set the number of days to whatever they want; however, these terms must often be agreed to in the contract with the payee. In addition, a payer may offer a discount (i.e. 1%) if payment is made within a short period of time (i.e. 10 days). This is written as 1/10, net 30, and the company may offer that discount if it is urgent they receive cash.

Installment Payments

In a very basic, transactional contract, a good or service is provided at the same time, immediately proceeding, or immediately following payment. Consider buying an apple at a grocery store; you must pay before you can take it out of the store. Consider a haircut; you must pay immediately after the barber styles your hair.

For more complex agreements that may require delivery of a good or a service to be performed over time, Consider a real estate developer that charges a 4% fee on a building they are constructing. The agreement for the developer fee may call for quarterly payments to the developer based on the percentage of completion of the building. Another example may be keeping a lawyer on retainer; payment must be made on a recurring basis in advance of any services being provided.

Advance Payments (Prepayments)

In some contractual situations, one party to the contract may require payment upfront before service has been performed or the good has been delivered. More often for service agreements, the payee that receives payment has an obligation to perform on the contract after payment has been received. In addition, that payee must follow strict accounting guidance that limits their ability to record revenue until the payment is actually earned.

The Bottom Line

The world has always entered into agreements where one party pays another. The idea of trade and contracts will never go away, but the form in which payment is made has and will change over time. Today, instead of trading for cash, there are many different ways to make payment that rely on the Internet, technology, or digital platforms.