What is a chargeback? What it means, how to lower the chances of it happening

If you make a purchase using your debit, credit or prepaid card and the sale doesn’t pan out as you expected, you can claim a chargeback to have your payment returned to you. 

But while chargebacks provide financial protection and peace of mind to you as a consumer, they can also pose a challenge to you as a small business owner.

Whether your business offers online payment methods, accepts card payments over the phone, takes in-person card machine payments, or all of the above, there’s always the chance of customers initiating chargebacks. This can disrupt your business operations and put a dent in your cash flow. 

That’s why we’ve put together this guide covering everything an entrepreneur needs to know about the process, including precisely what a chargeback means, how to do a chargeback, and the measures you can take to lower your chances of receiving a chargeback request while running your business.

What does chargeback mean?

A chargeback is when a debit, credit or prepaid cardholder disputes a payment they’ve made for a product or service, and attempts to have the transaction reversed so that the money is returned to their account. 

At first glance, this sounds identical to requesting a refund, but there are key differences. With a refund, the cardholder and the merchant are in direct communication with no third party involved, and the merchant agrees to return the money according to the terms of their refund policy.

By contrast, a chargeback involves the cardholder asking the bank or financial services company which issued their card to reverse the transaction. The card issuer then acts as a kind of referee in the process, assessing whether the customer has grounds to get their money back from the merchant account. 

If the merchant believes the cardholder’s request has been made in bad faith, or is due to a misunderstanding, they can contest the cardholder’s request and make their case that the transaction was in fact legitimate.

How does a chargeback work?

Let’s run through how a chargeback typically works in practice.

• A cardholder makes a cashless payment online – say, the purchase of an item using their debit card. The item turns out to be damaged and is returned, but the merchant doesn’t reply to the cardholder’s request for a refund. 

• The cardholder notifies the card issuer – their bank – that they would like to dispute the transaction. They’ll need to provide the bank with details of the item in question, the amount paid, delivery date, proof that the item was returned, and any communications with the merchant. (Note that there’s a 120-day time limit for the submission of most chargeback requests.)

• The merchant’s bank is notified of the chargeback request, and the merchant will either accept or contest the chargeback claim. If they contest it, they’ll have to provide a formal rebuttal statement along with any documentation that proves the cardholder’s purchase was valid. This step is often referred to as representment. 

The card issuer assesses the evidence on both sides and comes down in favour of either the cardholder or the merchant. The card network itself (Visa, Mastercard or American Express) may make the final decision in what’s known as arbitration.

What qualifies for chargebacks?

Whatever small business ideas you’re bringing to life – whether you’re exploring creative ways to make money like selling handmade crockery, or perhaps rolling out passive income ideas like selling dropshipped items – there are numerous reasons why your customers may initiate chargebacks.

Friendly fraud

Despite its rather innocuous-sounding name, friendly fraud is a major headache for all kinds of enterprises, from major corporations to low cost businesses run from home. The term applies when a cardholder makes a chargeback request for a transaction that was in fact completely legitimate.

Friendly fraud can occur unintentionally, if for example:

• The cardholder doesn’t recognise the charge for your product or service on their bank statement or credit card bill, either because they’ve forgotten about the transaction or they don’t realise the charge refers to your business.

• The cardholder doesn’t realise that a family member made the purchase using their card (a sub-category known as family fraud).

• The delivery of an item is delayed or cancelled by the courier, or the item turns out to be faulty, and the cardholder mistakenly believes that filing a chargeback is the only way to rectify the issue. 

Friendly fraud can also happen on purpose, if for example:

• The cardholder claims an item didn’t arrive when it did, in order to get the money on the purchase while keeping the item. This is a form of chargeback fraud commonly dubbed “cyber shoplifting”.

• The cardholder has broken the terms of your order cancellation or refund policy, perhaps getting buyer’s remorse after a certain amount of time, and is adamant that the money they paid should still be returned to them.

• The cardholder wants to end a subscription before the contract expires, or simply can’t be bothered to go through the correct cancellation process. 

True fraud

By contrast to friendly fraud, where a customer known to the merchant disputes a transaction they or their family member made, true fraud is when a criminal makes an unauthorised purchase using the cardholder’s details. 

Say you specialise in high-value things to make and sell, and a fraudster purchases items from you through an online payment gateway using stolen credit card details. The real cardholder may then decide to pursue a chargeback when they realise they’ve become a victim of credit card fraud.

Merchant error

Prepaid, debit and credit card chargeback requests are sometimes raised because of an error or issue on the merchant’s side. This may be due to negligence, human error or a technical glitch which nobody could have predicted, but in any case it might be enough to lead to a flawed transaction and/or leave the cardholder out of pocket.

Examples of such issues include:

• The cardholder being overcharged. 

• The cardholder being charged more than once for the same purchase.

• A product or service description or image on the merchant’s website being inaccurate or misleading, resulting in the cardholder making the wrong purchase.

• A faulty or damaged product being sold (whether willfully or by accident).

If your operations management is on point and you have a clear process for dealing with complaints and refunds, then disgruntled cardholders shouldn’t feel the need to trigger a chargeback. However, any real or perceived slip up on your side may cause a customer to go down that road.

For example, let’s imagine you’ve been thinking of online business ideas and decide to launch an online store selling repurposed vintage furniture. A customer orders a custom-designed coffee table, paying with their debit card. An honest mistake by you during the carpentry process means that the table breaks soon after being delivered.

The customer sends you an email to complain and enquire about your returns policy, but for some reason it gets lost in your inbox and doesn’t come to your notice. They then receive an automated email from your business, asking them to leave a customer review. This aggravates the customer, and they decide to raise a chargeback.

This example illustrates how, no matter the size or complexity of your business, whether you run a buzzing food and drink emporium or you’re only interested in how to make money from home, it’s important to make yourself as “chargeback-proof” as possible. 

We’ll delve deeper into that later in this guide, after considering a key question…

How can chargebacks harm your business?

From senior executives at large companies to part-time entrepreneurs pursuing ideas for second income generation, no business owner wants to see chargeback notifications turn up on their to-do lists. Here are the main reasons why.

Financial impact 

Chargebacks can negatively impact your small business finances in a few ways. First up, there’s the fact that if the bank or card network finds in the cardholder’s favour, it means you’ll lose the money you made on the sale. 

Regardless of whether the chargeback was legitimate or not, or whether it was down to an error on your part or something beyond your control, the abrupt deduction of that money from your business account will deal a blow to your operating cash flow. Depending on how much the transaction was worth, it may even put you into negative cash flow for the accounting period.

On top of this, there’s the issue of chargeback fees. As a merchant, you’ll likely be charged by your bank or card payment processor for each chargeback you receive. Fees vary between financial institutions, but can be anything between £15 to upwards of £100. 

If your business sells physical goods and these aren’t returned, that adds to the financial losses associated with each chargeback.

Reputational impact

Over time, repeatedly incurring chargebacks can damage the reputation of your business in the eyes of financial institutions. When assessing businesses, banks and card networks will consider chargeback ratios, which is the percentage of sales which have resulted in chargebacks.

Let’s say you’re making money online by selling items through an online store. In one month, your business sees 514 sales, of which seven turn into chargebacks. This would give you a chargeback ratio of 1.4%. 

As a general rule, anything over around 1% is considered a high chargeback ratio, and may mean your business is subject to closer monitoring and higher chargeback fees, and you may find it more difficult to get backing when planning how to scale your business. (If you’re in a sector which tends to run a higher probability of chargebacks, you may have to consider a high risk merchant account.)

It’s also important to bear in mind that it’s not just your standing in the eyes of banks and card providers that can be affected by chargebacks. Whether justified in their feelings or not, customers who feel like they’ve been let down can leave bad reviews for your business online, potentially undercutting your customer acquisition and business growth strategies.

Impact on operations

As well as costing money and possibly harming your reputation, chargebacks are also a considerable inconvenience which can add to your workload and slow down your daily operations. 

Putting together the evidence to dispute chargeback claims can be time consuming, diverting you away from things you’d much rather be doing such as brainstorming pricing strategies or conducting market research for small business success. 

How to dispute chargeback claims

If a cardholder issues a chargeback request because of genuine merchant error or because they’ve been the victim of true fraud, then the usual course of action is to accept the chargeback and absorb the financial loss into your small business budget.

But if you feel the claim is a case of friendly fraud (whether intentional or not), then you may want to dispute the claim through representment. 

When notifying you of the chargeback, the bank or financial institution handling your account will give you a deadline for submitting evidence that the cardholder’s claim is invalid. 

This evidence typically consists of:

• A succinct rebuttal letter which summarises the chargeback claim and lists what documents you’re attaching to prove the transaction was legitimate.

• The documents themselves, which can include invoices and sales receipts, screenshots of any emails, texts or social media messages between you and the cardholder, product photos, information from delivery companies, information on your refund and cancellation policies, and more.

Let’s consider some common chargeback scenarios and the kind of evidence which can be used to make your case.

The cardholder claims they didn’t authorise a purchase

Let’s say you’ve started an online business selling sporting equipment, and you receive an order for a set of dumbbells. You dispatch the items, only to be hit with a chargeback because the cardholder is claiming their debit card details were stolen, and they never authorised the transaction.  

The onus will be on you to prove that the cardholder did make the purchase themselves, which could mean submitting:

• Any communication with the cardholder which acknowledges the transaction.

• Cardholder authentication data, such as AVS and CVV checks, obtained through the payment security process when the purchase was made online.  

• Information related to shipping of the dumbbells, such as confirmation from the courier that the items were delivered to the cardholder.

The cardholder claims you’ve charged for a cancelled subscription

Say you’ve become your own boss by setting up a subscription box company which dispatches surprise assortments of beauty products to customers every month. A customer issues a chargeback, claiming you’ve carried on charging them despite their subscription being cancelled.

This claim may be invalid, either because you did not take further payments, or because the cardholder had violated the terms of the cancellation policy. You might support your argument by submitting:

• Details of your cancellation policy, emphasising any sections which might prove the cardholder is either misunderstanding or flouting its terms.

• Evidence that the cancellation policy and other important terms of business were made clear to the cardholder, either during the transaction process or in other communications.

• Evidence of reminders  and notifications you may have sent to the cardholder regarding payments and terms of the subscription.

• Business account statements proving you did not continue to charge the cardholder (if that is indeed the case).

The cardholder claims they never received a refund they were owed

Anyone pursuing retail business opportunities should be prepared to handle returns and refund requests. But what if a customer claims they were owed a refund but never got their money back from you or your limited company? 

It’s a common reason for chargebacks, and can be countered by submitting:

• Details of your refunds policy, emphasising any sections which prove the cardholder was not entitled to their money back (for example, because they requested it after a certain time frame, or because they’d returned a used product).

• Evidence that the refunds policy and other important terms of business were made clear to the cardholder, either during the transaction process or in other communications.

The cardholder claims they were misled on the sale

If you’re interested in business ideas with low investment, you might set up a print-on-demand enterprise where clothes and homeware items emblazoned with your bespoke designs are made to order. But what if a customer demands a chargeback, claiming your product descriptions were inaccurate?

If you believe they’re being unreasonable, or willfully trying to cyber shoplift your wares by getting their money back without legitimate grounds, then you can dispute the chargeback by submitting:

• The original product descriptions and photos of the items on your online store.

• Photos of example items you’ve taken yourself, to emphasise that they match the photos on your online store. 

• Any email, text or social media communications with the cardholder where they may have acknowledged receiving the items and being happy with them.

How to lower the risk of chargebacks

Whether you’re a sole trader, a partner or a director of a limited company, cutting the likelihood of prepaid, debit card and credit card chargebacks should be part of your small business risk management strategy. Here are some rules of thumb to follow.

1. Have clear refunds policy in place

No business wants customers to request refunds, but they’re far preferable to chargebacks. With a refund, you’ll have far greater control over the situation, communicating directly with the customer to address their concerns without any damage to your reputation in the eyes of banks and other financial institutions.

With this in mind, ensure your cancellations, returns and refunds policy is clearly stated on your business website and sales communications. 

Your terms should be written as clearly as possible, to minimise the chances of customers either being confused or viewing chargebacks as a simpler course of action. 

2. Provide accurate product and service descriptions

It’s vital to always manage client expectations so they don’t feel let down or misled after receiving your products and services. 

Product descriptions, photos and videos on your business website or online store must be as clear and accurate as possible. The same is true of any information sent out as part of your email marketing strategies, or when you’re using social media for small business outreach.  

By being absolutely transparent about what your business does (and what it can’t do), you’ll reduce the chances of having to deal with difficult clients later on.

3. Be clear about the delivery process

Chargebacks can be triggered if customers feel sidelined or let down by the delivery process. For example, if an item is late or goes AWOL without explanation.  

So, if you’re looking into how to start a business which dispatches physical items to customers, you should make sure customers are always informed about every stage of the order and delivery process. 

Ideally, emails should be sent to your customers confirming which delivery company you’re using, along with tracking numbers and links so customers can follow deliveries in real time. You should also include clear information on who should be contacted if deliveries are delayed or go missing.

4. Be identifiable on bank and card statements

Chargebacks are often triggered because cardholders don’t recognise payments listed on their bank and credit card statements. That’s why it’s important that your billing descriptor – the text accompanying payments to your business – is readily identifiable.

Rather than referring to, say, a holding company or some other name that wouldn’t be familiar to customers, your billing descriptor should ideally be the name of your brand. This way, cardholders looking through their statements will get instant name recognition, and not jump to wrong conclusions.

5. Be accessible to your customers

Providing good customer service isn’t just important for customer retention. It’s also 

one of the most effective ways to reduce the risk of chargebacks, which are so often filed when customers feel like their questions and complaints regarding transactions aren’t being addressed.

Whether it’s by phone, email, social media, or in person, you should be ready to handle queries and problems in a prompt, friendly manner. This can nip issues in the bud, hopefully preventing a simple misunderstanding or rectifiable problem from turning into a chargeback claim.

6. Ensure employees are well trained

An ability to handle complaints and tactfully resolve tricky situations should also be among the attributes you look for when considering how to hire employees. Anyone you do hire should be well versed in business operations so they can quickly handle customer-focused challenges.

In fact, one of the benefits of training employees properly is that they’ll be able to help you with customer and clients management, and prevent situations escalating into chargebacks.  

7. Keep transaction records

As we saw earlier in this guide, being able to provide accurate information regarding transactions is essential for successfully disputing chargebacks.  

That’s why it’s important to retain records of sales, customer emails, and other information that may be very useful if chargebacks occur. The good news is that there’s plenty of software and hardware which make it easier to collect and keep data, from accounting tools for small businesses to point of sale systems for use in retail environments.

8. Be vigilant against fraud

Many customer chargebacks are completely legitimate, and are prompted by debit and credit card fraud carried out by criminals. Having small business cyber security and fraud detection measures in place will help you lower the chances of being targeted in this way.

Card not present transactions, where payments are taken remotely online, should undergo authentication processes to ensure a fraudster isn’t using stolen details. These include Address Verification Service (AVS) and CVV checks, and two factor authentication which requires cardholders to give the go-ahead for purchases.

Whatever software and hardware you’re using for your business, double check what measures are in place to prevent card not present fraud.