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ACH payment: What is it and how does it work?

ACH payment: What is it and how does it work?

What is an ACH payment?

An ACH payment is a payment sent via the ACH (Automated Clearing House) network, an electronic network used to send paperless payments between bank accounts in the United States. If you think of payments as the money taken out of your account when you have your monthly bills on autopay - that’s typically done via ACH. Deposits are a category that includes your paycheck coming via direct deposit.

The Automated Clearing House was established in the 1970s to deal with an increasing number of paper checks that required processing. It’s taken some time to grow to what it is today, but as the world gets faster it’s clear that ACH is necessary. We’ll also explain in this article what the differences are between ACH payments, EFT payments, and wire transfers.

How do ACH payments work?

An ACH payment first requires a data file with information about the transaction. The payment is processed after the file is sent to the originator's bank, then to the clearing house, and then, finally, to the recipient's bank, at which point the funds are transferred to the recipient's account.

Perhaps the most well-known example of an ACH transaction is payroll direct deposit. This is a good scenario to explain how the ACH network works, since many Americans receive their paychecks via direct deposit. The process of receiving a direct deposit via ACH involves the following:

  1. Employee signs up for direct deposit
  2. Employee provides employer bank routing and account number
  3. Employer enters this information into a payroll system
  4. On payday, the employer sends an electronic payment file to the bank
  5. The bank makes electronic ACH entries for each paycheck
  6. ACH operators at the bank sort payments to appropriate accounts
  7. ACH payment shows up in employee’s bank account

While this might sound like a long and tedious process, it happens much faster than the standard processing time for paper checks. ACH deposits are processed in batches at the end of the day, so employees can see money in their accounts within a few days. Typically, employers submit payroll requests two days before payday to make sure funds arrive on time.

Financial institutions can choose to have ACH credits processed and delivered within one business day, per guidelines set forth by NACHA. Those same guidelines state that ACH debits must be processed by the next business day. With an increasing need for faster transaction times, most major banks and credit unions are on this system.

Individuals can also receive social security benefits and tax refunds via ACH. Online applications like TurboTax and Quicken have this option built into their interface, so all you need to do is enter your bank account information and they’ll take care of the rest for you. It beats waiting for a check in the mail. If you file early, you may see funds in your account within a week.

ACH payments for recurring bills

In addition to direct deposits for payroll, the ACH network can be used for monthly recurring bill payments. Merchants prefer this method because the processing cost is lower than what they pay for credit card processing and faster than waiting for paper checks in the mail. Examples of the types of bills you may already be paying with ACH payments include:

  • Credit card monthly payments
  • Utility payments
  • Auto loan payments
  • Mortgage payments
  • Merchandise on monthly payments

Just so to be clear, bill payments are usually listed as ACH debits, while payments to your account from another entity, like the US Government or IRS, are classified as ACH credits. The difference is that credits are pushed into an account while debits are pulled out of the account. Hopefully, that alleviates any confusion.

To simplify this even further, ACH payments involve three other parties in addition to the Automated Clearing House itself. Those three parties are:

  • The Originating Depository Financial Institution (ODFI)
  • The Receiving Depository Institution (RDFI)
  • The National Automated Clearing House Association (NACHA)

The ODFI initiates the transaction and the RDFI receives it and processes it through the Automated Clear House. NACHA is the governmental agency that oversees and writes the regulations for the ACH. They protect you from fraud and ensure that the network works at optimal speed, so you don’t have to wait weeks for payments to process.

ACH payments vs. wire transfers vs. EFT payments

Many consumers either don’t know or don’t understand the difference between these payment methods, but there are some important distinctions between them.

First off, using the term “EFT payments” is just another way to describe ACH payments, so you can bundle those two together. They are the same thing. Wire transfers, on the other hand, are significantly different. Where ACH transfers can take several days to process, wire transfers are processed in real time. That means you can get your money within a few hours.

Of course, you pay for that convenience. Anyone who’s ever sent money using Western Union knows that the cost is high, sometimes as much as $60, depending on the amount being sent. It’s a nice option to have if someone needs funds quickly, but it’s too expensive for merchants to use as an everyday payment method. ACH transfers usually cost under $1.

Are ACH payments right for your business?

Setting your business up to receive ACH payments is a convenience to your customers, but is it actually worth it for you? There are some important points to review before answering that question. They mainly center around volume and current customer payment preferences. Some businesses are cash-only. ACH is not a good fit for those.

Does your business accept recurring payments? Subscription services and service providers generally fall into this category. Customers are able to make their monthly payments with credit cards, but the processing fees for the business can be expensive. ACH transaction fees are more cost effective. The median cost is just $0.29 per transaction.

Are you currently taking paper checks? Any business owner or manager who does daily reconciliation can tell you that counting checks at the end of the day is time consuming and inefficient. Handwritten checks are sometimes difficult to read and each one needs to be checked for proper date, amount, signature, and contact info. Paper checks are an archaic and outdated system. ACH transactions are faster and more efficient.

Of course, there are other factors to consider. Are your customers comfortable with online transactions? Most people are the days, but if you have an older customer base you may face some resistance. Making the transition to ACH transactions requires commitment from the business owner. It may take some time for customers to fully embrace it.

Count the number of checks and credit card transactions you’re currently receiving. Add up the processing fees and calculate the amount of time spent counting paper checks and credit card receipts at the end of the day. All of that can be eliminated by switching to ACH payments. It’s up to you to create a plan for the transition and implement it.

Some businesses are ineligible to accept credit and debit cards. These merchants are denied that privilege because they’re considered high risk for fraud or have a somewhat irregular payment history. If you’re in that category, ACH may be a good alternative for you. It’s either that or take cash only. And that of course comes with its own level of risk.

Setting up ACH payments for your business

Once you’ve made the decision to start accepting ACH payments for your business, the setup process is simple. If you’re using BILL, you only need to sign in, connect a bank account, and add customers or vendors. The mechanism to request ACH payments is already built into the software. If you’re doing this manually, here are the steps you need to take:

  • Set up an ACH Merchant Account: You’ll need a federal tax ID number for this. You will be asked how long you’ve been in business and what your estimated volume will be.
  • Request Customer Authorization: When done manually, this requires paper or online forms. You can do it with a phone call, but it’s better to have written documentation.
  • Set Up Payment Details: You’ll need bank routing and account numbers from each of your customers, along with payment amounts and frequency.
  • Submit Payment Information: You’ll need payment processing software for this, so it’s probably simpler to just let BILL handle the whole process for you.

Benefits of using the ACH network

If you’re considering the ACH network for business payment processing, there are several benefits to consider. They include:

  • Lower Processing Fees: ACH transactions fees average out at $0.29. Credit card processing costs, on average, 1.3% to 3.5% of the transaction. Do the math. There’s a significant savings potential with using ACH payments.
  • Fewer Declined Transactions: Credit cards get denied and checks bounce. Insufficient funds can happen when using ACH, but it's less common and the bank is on your side when it comes to collecting the payments that are due.
  • Convenience for You: Put away the desktop calculator and overnight deposit bag. ACH transactions are processed electronically. BILL can provide you a financial ledger to use for record keeping and tax filings.
  • Convenience for Your Customers: Autopay by ACH payment is far from a new concept. Most consumers are already doing it for bill paying. Offering it as a payment option for your business is adding a convenience. Your customers will appreciate you for it.

Drawbacks of using the ACH network

It wouldn’t be objective of us to not include the potential drawbacks of using ACH. There are a few of these, some of which only apply to certain types of businesses, like those who do business internationally. Review these before you start the setup process:

  • Processing Speed: Depending on how you set it up, ACH payments could take 3-5 business days to process. This can be an inconvenience.
  • Transfer Limits: There is a same-day maximum transfer amount of $25,000 with the ACH network. If your volume is higher than that, this could be a problem.
  • Cutoff Times: This is listed as a drawback, but paper check deposits don’t count until the next day if made after 2:00 PM. ACH transactions are no different.
  • International Transactions: The ACH network is only available inside the United States, so businesses operating internationally will need another option.

ACH rejection codes and reasons

Though rejections and denials are a risk with any payment method (except cash), this might be considered another drawback. There are times when a request for an ACH payment or deposit may be rejected. There are several reasons that could happen. If you experience this, look for one of the following rejection codes on the transaction statement:

  • R01: Insufficient Funds: This is most often seen when a customer initiates a payment and doesn’t have enough money in their account to cover it. The customer should contact their financial institution right away if this happens to avoid NSF fees.
  • R02: Bank Account Closed: When an account has been closed and the payer doesn’t inform the payee, this rejection code will appear on the payee side. The best course of action is to call the customer and get updated account information.
  • R03: Unable to Locate Account: Did you “fat finger” the data when you typed it in. R03 codes are often an error on the payee side. It’s possible you were given incorrect information, but you should check your own work before you jump to conclusions.
  • R04: Rejection: When the system kicks back a simple R04 “Reject” response, it means that the bank is not allowing the sender to withdraw funds from that account. In most cases, the bank just needs an originator code to enable ACH withdrawals.

Like checks with insufficient funds (NSF), the bank will charge a fee if your business triggers a rejection code. This may have been caused by an inadvertent error on the data entry side or due to an accounting mistake. Either way, contact your bank right away of you get a rejection code. They might be willing to waive the fee if you act promptly.


Is the Automated Clearing House secure?

NACHA has a set of rules and regulations that govern the ACH process and determine eligibility for businesses using the network. Among those mandates is the requirement that businesses and third-party processors encrypt banking information with “commercially reasonable” technology. Today, that means 256-bit SSL encryption. Additional security is provided by the payment processor. Together, these requirements make the ACH process very secure.

What’s the difference between an ACH payment and direct deposit?

Direct deposit is simply a type of ACH payment. In fact, direct deposit is perhaps the most common type of ACH payment, seeing how common it is for employees to receive their paycheck via direct deposit.

How long does it take for an ACH payment to go through?

ACH payments may take one to three business days to complete. ACH payments are not instantaneous, and are processed in batches throughout the day. Depending on a variety of factors, including the bank doing due diligence to ensure sufficient funds are available, the payment may take a few business days to go through.

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