Chargeback vs refund explained for SMEs

Unlock the secrets to navigating chargebacks, refunds, and keeping your small business thriving with this simple guide.

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Chargeback and refund are two terms often used interchangeably to describe situations in which dissatisfied customers want to reverse purchases and get their money back – but there are some very important distinctions to be made

When you provide a refund, you are choosing to resolve the issues peacefully with your customer; when a chargeback is requested, funds are returned by force. One is a friendly peace treaty, the other is a hostile takeover.

Chargebacks also come with additional fees for the merchant and increase a merchant’s chargeback ratio. If a merchant’s chargeback ratio exceeds certain thresholds, it can spell a lot of trouble for businesses – it can trigger a series of escalating consequences that can negatively impact the merchant’s ability to process card payments and conduct business smoothly. 

So it goes without saying that as a small or medium-sized enterprise (SME), it’s important that you understand what chargebacks and refunds truly mean for you and your business — the differences between them, and what steps you can take to reduce the frequency of both chargebacks and refunds. In this article, we’ll dive into the nuances.

What is the difference between a chargeback and a refund?

At first glance, chargebacks and refunds might seem like two sides of the same coin, both resulting in money returning to the customer. However, these two mechanisms serve distinct purposes in the world of commerce.

A refund is a straightforward process initiated by the business. It involves returning the purchase amount to the customer, often due to dissatisfaction, returns, or cancellations. These are a natural part of business operations that occur from time to time, and when managed correctly can help to maintain customer trust and satisfaction.

On the other hand, a chargeback is a more intricate process that usually involves the customer’s bank. Chargebacks are typically triggered when a customer disputes a transaction directly with their bank, often due to unauthorised or fraudulent transactions. The bank then reverses the transaction, returning funds to the customer and initiating an investigation into the matter.

Chargebacks can lead to financial strain, administrative burden, and potential damage to your business’s reputation, especially if they’re not handled appropriately. Refunds, while more controllable, might affect cash flow temporarily but contribute positively to customer satisfaction and trust.

Are chargebacks or refunds better for SMEs?

Refunds are often the preferred course of action due to their controlled nature and positive impact on customer relations.

Think about it: when someone issues a chargeback, that means they have essentially gone above your head providing no way to defend yourself as a company or explain to your customer what the exact issues may have been. 

It also leaves a lack of conclusive data on your part, because since the customer has ceased communications with you (or never began in the first place) it is almost impossible to understand what the real issue was, or how you can improve for future sales and provide a better customer experience in your business in future.

The impact of chargebacks and refunds on SMEs

Both chargebacks and refunds can have significant impacts on small businesses. 

Chargebacks can lead to financial strain, administrative burden, and potential damage to your business’s reputation, especially if they’re not handled appropriately. 

Here are some potential consequences that merchants might face if their chargeback ratio surpasses predefined thresholds:

  • Fines and fees: merchants with high chargeback ratios can be subjected to fines or penalties imposed by payment processors or card networks. These fines are meant to encourage merchants to take measures to reduce chargebacks and maintain better business practices.
  • Higher processing fees: a high chargeback ratio can lead to the merchant being categorised as high-risk. As a result, payment processors might impose higher processing fees for each transaction to compensate for the increased risk associated with potential chargebacks.
  • Monitoring programs: some payment processors or card networks might place a merchant in a monitoring program if their chargeback ratio is consistently elevated. This can involve increased oversight, additional reporting requirements, and closer scrutiny of the merchant’s transactions.
  • Termination of services: if a merchant’s chargeback ratio remains consistently high and efforts to address the issue are not effective, payment processors or card networks might consider terminating their services altogether. This can severely disrupt the merchant’s ability to process payments and conduct business.
  • Placement on the “Terminated Merchant File”: The Terminated Merchant File (TMF) is a UK database shared among card networks that contains information about merchants who have been terminated due to excessive chargebacks or other violations. Being placed on this list can make it difficult for a merchant to secure services from other payment processors.
  • Reputational damage: high chargeback ratios can tarnish a merchant’s reputation in the eyes of customers, financial institutions, and industry regulators. This can lead to decreased customer trust and diminished sales.

How SMEs can reduce the risk of chargebacks and refunds

Some customers request a chargeback because they think it’s the same as a refund and aren’t aware of the implications for your business. 

A lot of customers have been burnt in the past by less than ethical businesses. They have resorted to the chargeback process with success and have simply continued to use that course of action. 

To mitigate the risk of these situations, SMEs can adopt a variety of strategies: 

  • Clear communication and transparent policies: ensure that your customers have a clear understanding of your products, services, and policies. Provide detailed and accurate product descriptions, terms of sale, refund, and return policies on your website. Transparent communication helps manage customer expectations and reduces the likelihood of disputes.
  • Provide excellent customer service: deliver exceptional customer service by promptly responding to inquiries, concerns, and complaints. Addressing issues in a professional and empathetic manner can often prevent customers from resorting to chargebacks or refunds.
  • Secure payment processing: use secure and reliable payment processing platforms to minimise the risk of unauthorised transactions and fraud. Implement robust fraud detection mechanisms that identify suspicious activities and prevent fraudulent purchases.
  • Accurate billing descriptors: ensure that your business’s name and contact information are clearly displayed on customer billing statements. This prevents confusion and reduces the likelihood of customers initiating chargebacks due to unrecognised transactions.
  • Comprehensive product descriptions: provide accurate and detailed product descriptions, images, and sizing information on your website. Misunderstandings about product details can lead to customer dissatisfaction and the need for refunds.
  • Efficient order fulfilment: adhere to promised delivery times and shipping methods. Late or incorrect deliveries can lead to customer frustration and increase the chances of refunds or chargebacks.
  • Secure transactions: Implement strong security measures to protect customer payment information. Utilise SSL certificates on your website by choosing a website provider that offers them, comply with Payment Card Industry Data Security Standard (PCI DSS) requirements, and stay updated on cybersecurity best practices.
  • Clear refund and return policies: create clear, concise, and easy-to-understand refund and return policies. Make sure customers know how to request refunds or returns, the timeframes involved, and any associated terms or fees.
  • Accurate inventory management: maintain accurate inventory records to prevent overselling or discrepancies in product availability. Selling products you can’t deliver can lead to customer disappointment and potential refunds.
  • Data analytics and monitoring: regularly review transaction data and monitor patterns for any irregularities or spikes in chargebacks or refunds. Identifying trends early can help you address potential issues swiftly.
  • Dispute resolution process: establish a streamlined process for handling customer disputes. Train your staff to address customer concerns effectively and professionally, aiming to resolve issues before they escalate to chargebacks.
  • Customer feedback loop: encourage customers to provide feedback on their experiences with your products and services. This feedback can help you identify areas for improvement and reduce the likelihood of dissatisfaction.
  • Continuous improvement: regularly assess your business processes and customer feedback to identify areas where you can enhance customer satisfaction and reduce the risk of disputes.

How to encourage refunds over chargebacks

While chargebacks are often outside your direct control, focusing on minimising them through impeccable customer service and secure payment processing is crucial. 

Emphasising your commitment to customer satisfaction and personalised service can go a long way. Communicate the fact that you’re a dedicated, independently-owned enterprise striving to provide the best experience possible. 

Offering incentives like special discount codes or exclusive offers for future purchases can demonstrate your willingness to rectify any concerns and ensure customer contentment. 

By choosing a refund route, educate customers on the fact that not only are they supporting your small business by choosing to resolve issues amicably, but also contributing to the unique ecosystem of local commerce. Emphasise the value of community and mutual understanding.

Encouraging customers to seek refunds directly from your business rather than resorting to chargebacks will help to maintain smooth operations and build stronger relationships.

What is a double refund chargeback?

Case Study: The Double Chargeback Dilemma

Imagine a small online boutique called “ChicStyles” that specialises in selling fashion accessories. They have an active online presence and receive a significant portion of their revenue through online transactions. Alice, one of their loyal customers, recently made a purchase of a designer handbag worth £200 from ChicStyles.

A few weeks after Alice’s purchase, she discovers an unauthorised charge on her credit card statement for £500, which she believes is linked to her ChicStyles transaction. Concerned about potential fraud, Alice contacts her bank and initiates a chargeback for the £500 charge.

Upon receiving the chargeback request, Alice’s bank conducts an investigation and determines that the £500 charge is indeed fraudulent. The bank reverses the transaction and returns the £500 to Alice’s account, as part of the chargeback process.

Now, here’s where the double chargeback scenario unfolds. While Alice’s bank successfully reverses the fraudulent £500 charge, ChicStyles also receives a notification of the chargeback and sees the transaction for the original £200 purchase reversed. 

This effectively means that Alice’s purchase of the designer handbag has been refunded twice – once by ChicStyles directly and once through the chargeback process.

The occurrence of a double chargeback presents a challenge for ChicStyles. Not only have they lost the £200 from the sale of the handbag, but they are also subject to a chargeback fee imposed by their payment processor. This fee is typically intended to cover administrative costs associated with handling chargebacks, whether you were particularly at fault or not.

This translates into a financial loss, which can impact their cash flow and profitability, particularly for small businesses like them.

Preventing double chargebacks:

To prevent double chargebacks, businesses like ChicStyles need to ensure effective communication and documentation. When a customer contacts them with a concern or issue, it’s crucial to address it promptly. In this case, ChicStyles could have proactively resolved Alice’s concerns about the unauthorised charge, avoiding the need for her to initiate a chargeback in the first place.

Chargeback vs refund: summary

The distinction between chargebacks and refunds is vital for SMEs seeking sustainable growth. 

Refunds, a proactive approach to resolving customer concerns, foster trust and loyalty, nurturing the customer-business relationship. On the flip side, chargebacks, though a recourse available to customers, can have far-reaching consequences, impacting finances and reputation. 

As SMEs strive to strike a balance between these mechanisms, the implementation of preventive measures becomes paramount. By ensuring transparency, exceptional customer service, and secure payment processing, businesses can mitigate the risk of chargebacks and refunds. 

Each interaction is an opportunity to not only showcase your dedication to customer satisfaction but also to solidify your place within the market. As you navigate the complexities you can position your SME to thrive and become a testament to customer-centric excellence in the industry.


Frequently Asked Questions
  • Is a chargeback legally binding?
    No - a chargeback is not inherently legally binding, but is a dispute mechanism provided by payment networks that can affect your business reputation if not complied with.
  • What justifies a chargeback?
    A chargeback is typically justified when a customer experiences unauthorised transactions, fraud, goods not received, or a billing error.
  • Who gets charged for a chargeback?
    The merchant who received the payment usually bears the financial impact of a chargeback, including potential fees.
Written by:
Stephanie Lennox is the resident funding & finance expert at Startups: A successful startup founder in her own right, 2x bestselling author and business strategist, she covers everything from business grants and loans to venture capital and angel investing. With over 14 years of hands-on experience in the startup industry, Stephanie is passionate about how business owners can not only survive but thrive in the face of turbulent financial times and economic crises. With a background in media, publishing, finance and sales psychology, and an education at Oxford University, Stephanie has been featured on all things 'entrepreneur' in such prominent media outlets as The Bookseller, The Guardian, TimeOut, The Southbank Centre and ITV News, as well as several other national publications.

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