Whether your small business sells quirky embroidery kits or home brew equipment, you’ll likely have some customers who will make a purchase only to change their minds down the line. If your customers are paying with credit cards, this means chargebacks. And rolling reserves.
A rolling reserve holds a portion of your gross credit card sale amounts to ensure you’re able to honor a chargeback – or return of money to the purchaser – if it’s requested.
Although these accounts are useful for ensuring you have enough cash to honor a refund, they can be challenging for new business owners. Especially when your merchant account isn’t credited with 100% of the proceeds you were expecting from your credit card sales.
To ensure you avoid any unwelcome surprises when it comes to credit card sales, I’ll shed some light on everything you need to know about rolling reserves, from what they are and why they exist to how they function and affect your business.
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What Is a Rolling Reserve?
A rolling reserve is like an insurance policy for banks and payment processors. It’s an amount that these entities require businesses to have available to cover any chargebacks they may need to honor.
If a business goes bust, commits fraud, or otherwise fails to honor an agreement, the rolling reserve protects both the payment processor and the business’s bank. The reserve has enough cash in it to return funds to customers if they request a refund, or successfully dispute a charge.
These contingency funds work in one of two ways. They may either be held back by payment processors for a set period of time before being paid over to your merchant bank, or your bank may create a sub account to separate the funds from the rest of your income.
How Does a Rolling Reserve Account Work?
To understand how a rolling reserve account works, you need to have an understanding of how credit card transactions function.
Let’s say that Customer A buys a product. When this happens, their bank pays the funds from their account over to your bank. Your bank then deposits those funds into your merchant account. Simple, right?
Things get a little more complicated when you consider the relationship between A and their issuing bank (the bank that gave them their credit card). Although A’s funds appear in your bank account within a few days of the transaction, A may pay their bank back over a longer period. Plus, they usually have between 90 and 120 days to request a chargeback.
Because of these factors, A’s bank doesn’t actually release their funds to your account immediately. Instead, they issue your bank with a credit.
If A decides to return your product and claims a chargeback, and the payment processor is satisfied that this is a valid claim, they will refund A’s money immediately. The processor will then request that your bank reimburses it.
The chargeback amount – along with any other costs associated with it – will be taken from your account to satisfy the payment processor’s request. To ensure that you’re able to meet these types of obligations, your bank takes a portion of each credit card sale you make and allocates it to your rolling reserve.
Each bank has different terms and conditions when it comes to rolling reserves, but the funds may be held for anything from three to six months. If a chargeback hasn’t been requested during this period, your bank will pay the relevant portion of the rolling reserve into your current account.
How Can a Rolling Reserve Affect Your Business?
A rolling reserve will affect your business’s cash flow. How great the effect will be depends on the proportion of sales paid for with credit cards, as opposed to other payment methods.
The more of your sales that come from these sources, the more money will need to be in reserve and the less cash you will have available to reinvest in your business. If you aren’t savvy about pricing your products, this could result in cash flow issues, reduced profitability, slower growth and underperformance.
Other Types of Reserve Funds For Credit Card Processing
Rolling reserves are just one type of merchant reserve account. The other two prominent types are up-front and capped reserves.
Up-Front Reserves
Payment processors will often require up-front reserves from new businesses that don’t have any earnings history.
As the name suggests, up-front reserves require the merchant to pay funds into their reserve before they accept credit card payments. This type of account may also be called a minimum reserve.
Usually, the up-front reserve will be loaded by transferring funds from your checking account or providing a letter of credit from your merchant bank. If neither of these options are workable, your bank may agree to withhold 100% of the value of all your credit card transactions until the minimum amount is met.
Capped Reserves
Also known as accrual reserves, these accounts place a restriction on the amount of money that can be kept in them. A portion of your sales will accrue to the reserve until it reaches the limit, which is usually a percentage of the total value of the transactions your business processes in a month.
Unlike rolling reserves, funds in capped reserves aren’t usually released to your current account and will be held until you close the reserve account.
How Much Is a Typical Reserve Amount?
The amount of money held in reserve will depend on the rules put in place by your payment processor and merchant bank, as well as the value of your sales.
Rolling reserves are typically around 5% to 10% of a business’s gross sales.
What Can You Do If Your Funds Are Being Held in a Reserve?
The amount of funds that are held in reserve – and the amount of time they’re held for – will generally be determined by your bank or payment processor.
To change the period or amount, you can speak to your bank after a few months of trading and ask for a review of the terms of your agreement. If you can prove that your business risk is lower than originally thought or that you have fewer chargebacks, the bank may be willing to reduce the reserve amount or release time.
In the event that you decide to change banks, switch to a new payment services provider, or perhaps close your business, the bank won’t immediately release your reserve funds. Here, it’s important to keep track of the funds that are in your account as well as when they should be paid out.
You may also be able to claim a large portion of these reserves immediately if your business has a good track record with few chargebacks. If the real risk to the bank is lower than the amount in your account, it’s likely they will reimburse you quickly.
The Bottom Line: Rolling Reserves and How They Affect You
Although a rolling reserve is an excellent tool for protecting banks and payment processors, it can have adverse effects on your business if you don’t handle it cleverly. First and foremost, your cash flow could suffer. This, in turn, can affect your ability to grow your business and remain competitive in your market.
That being said, rolling reserves also provide the benefit of protecting your business in the event that clients request chargebacks. Not only do they cover all or part of the refund amount, but they also offset any fees associated with the chargeback.
What’s important here is to ensure that you have a clear idea of how much cash you need to keep your business running. Once you know this, you can price your goods and services to ensure your net profit will sit above this threshold.
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