What Are ACH Payments? How ACH Transactions Work

When researching your options for a payment system, you may have come across the choice of supporting ACH transactions but weren’t quite sure if they applied to your business.

While ACH transactions make the most sense for merchants running eCommerce businesses, any merchant who conducts online or recurring transactions in any capacity could benefit from implementing ACH.

We going to cover the ins and outs of ACH payment below.

What is ACH?

ACH stands for Automated Clearing House, and you can think of it like a check without the paper. If you’re enrolled in a direct deposit program or pay your bills with monthly auto-drafts, you’re already used to using ACH.

To dig deeper, let’s define the individual terms:

  • Automated – This just means there’s no manual process involved once ACH payments are set up. It’s a batch processing system that computers handle at the end of each day automatically.
  • Clearing House – The ACH network (the system in which ACH payments flow in and out of) uses two main clearing houses. These clearing houses are either the Federal Reserve or The Clearing House, acting as the liaison between all the financial institutions that use ACH.

Examples of ACH transactions:

  • Automatic bank drafts from SaaS services
  • Direct deposits from your employer
  • Automatic bank drafts from utilities
  • Bank transfers

ACH transactions move upwards of $51 trillion dollars across 23 billion transactions. With that in mind, it’s no surprise that ACH now represents a significant portion of the financial transaction market, and it is widely considered a safe and reliable option for both B2B and B2C transactions.

How does ACH payment processing work?

ACH payments are easy to understand on the surface level, but what’s going on behind the scenes is actually quite complicated and fascinating. Here’s is what exactly is going on via NACHA.org (the electronic payments association that governs ACH payments):

  1. An Originator – whether that’s an individual, a corporation, or another entity – initiates either a Direct Deposit or Direct Payment transaction using the ACH Network. ACH transactions can be either debit or credit payments and commonly include Direct Deposit of payroll, government and Social Security benefits, mortgage and bill payments, online banking payments, person-to-person (P2P), and business-to-business (B2B) payments, to name a few.
  2. Instead of using paper checks, ACH entries are entered and transmitted electronically, making transactions quicker, safer, and easier.
  3. The Originating Depository Financial institution (ODFI) enters the ACH entry at the request of the Originator.
  4. The ODFI aggregates payments from customers and transmits them in batches at regular, predetermined intervals to an ACH Operator.
  5. ACH Operators (two central clearing facilities: The Federal Reserve or The Clearing House) receive batches of ACH entries from the ODFI.
  6. The ACH transactions are sorted and made available by the ACH Operator to the Receiving Depository Financial Institution (RDFI).
  7. The Receiver’s account is debited or credited by the RDFI, according to the type of ACH entry. Individuals, businesses, and other entities can all be Receivers.
  8. Each ACH credit transaction settles in one to two business days, and each debit transaction settles in just one business day, as per the Rules.

How ACH compares to other transaction methods

Here are the most important points for business owners to know:

  • ACH processes transactions in batches instead of individually.
  • There are two types of transactions available: direct deposits and direct payments.
  • Funds aren’t guaranteed, so withdrawals can “bounce” just like a check.
  • Daily ACH transfer limits are capped at $25,000.
  • ACH doesn’t run on weekends.
  • ACH is specific to the U.S. and Puerto Rico, so using ACH for international payments is usually not available.

How long do ACH payments take to process?

While the ACH payment processing time isn’t as fast as credit cards, transactions do move quickly. It usually takes a few days for a transaction to transfer, and that speed is increasing every year.

Why does ACH take longer than other transaction types?

While NACHA’s guidelines make sure credits are processed within 1-2 days and debits by the next day, the receiving bank usually takes a few more days to process the fees from the ACH network.

Good news is on the way, though! ACH payments typically batch only once at the end of the day, but NACHA is working on changing that frequency to three times a day in 2018.

Why your business should accept ACH transactions

Well, let’s start with the most direct motivator:

1. ACH is the cheapest transaction method.

When running a business, you’ll notice that common transactions typically fall into three categories: ACH, Paper Check, and Credit/Debit cards, and ACH is cheaper by far.

Let’s do a bit of math to demonstrate:

If you’re selling an item at a list price of $300, let’s consider the fees via each transaction method. It will never be uniform across the board, but let’s play along for this example.

Typical fees for each type are approximately:

  • Paper check – $1.57
  • Credit/debit card – $5.80 (1.9% X $300 fee + $0.10 transaction fee)
  • ACH fees – $0.26 – $0.50 (depending on the assumed risk)

In this example, the ACH isn’t even 10% of the card transaction projected cost. And keep in mind, this is just a single payment, so if your business is conducting even 100 of these transactions every few months, you could be saving around $500 year after year.

2. ACH is great for subscription services.

If you offer any sort of recurring service or product (e.g. monthly coffee deliveries), then ACH transactions are a great option for you. Customers don’t have to worry about paying you every month since ACH supports auto-draft capabilities, and you don’t have to worry about spending time and energy tracking down payments.

Plus, you’re likely to have fewer headaches since ACH transactions can only be disputed for three reasons: the charge was the wrong amount, it was authorized earlier than anticipated, or it wasn’t authorized at all. This reduces the payment hassles that typically accompany credit card transactions — especially when handling larger transaction amounts.

3. ACH is considered “preferred funding”.

Banks process electronic payments first, which means your business will get paid faster than physical checks by transacting via ACH.

ACH transactions are usually processed the next day and transferred within 3-5 days, and companies are improving that speed by the day.

4. ACH is more secure.

With high profile credit breaches serving up harrowing reminders of the importance of cybersecurity and with financial fraud on the rise, it’s important to take the security of your customer’s financial assets seriously.

The same information required for checks is required for ACH, but it’s all transferred over an encrypted network and doesn’t pass through multiple hands as a physical check does.

Make sure that the ACH provider you choose has stringent security measures in place to prevent information leaks. NACHA keeps a close eye on ACH security, and their rules outline a variety of processes you and your processor need to follow to remain compliant.

Their goal is to provide the ACH service while protecting sensitive customer data, so any transfer of information over an unencrypted network or vulnerable web forms is strictly prohibited.

5. ACH reduces paper waste.

Supporting ACH reduces the need for paper checks, and this reduces paper waste while saving you time and money.

Why ACH is better for customers

The benefits aren’t just on the business side. ACH payments can be much more convenient for consumers when paying for certain types of services, retainers, and subscriptions.

Benefits include:

  • Individuals get paid quickly and reliably without suffering costly fees.
  • Customers don’t have to worry about paying every month for service, saving them time and headaches.
  • Setting up accounts means consumers can purchase without having to enter their information every time.
  • They don’t have to keep up with a bunch of paper bills and checks.

How to set up ACH for your business

Setting up ACH requires a bit of paperwork but isn’t all that difficult, and it is supported by most major payment processing services, including Tidal Commerce.

It’s possible that you’re already set up to accept ACH payments, but you’re just not taking advantage of that service offered by your payment processor. Your first step is to look into your existing provider and see if they offer it.

Either way, it’s a smart decision to do a bit of shopping around when it comes to payment providers that offer ACH capabilities. There are a lot of options, and many payment processors fail to pass on sufficient savings to their customers.

Make sure you compare the offer your existing payment processor is giving you with a variety of businesses online. As represented in the scenario above, even a small rate change can have a large, compounding effect moving forward.

If you’d like to know exactly how much you could save by introducing ACH into your business process model, have the Tidal Commerce team review your payment statements for free and offer suggestions on how to cut costs.

What to ask of customers when accepting ACH payments

While setting up ACH isn’t as easy as accepting a credit card, the benefits often outweigh the inconvenience. When setting up an ACH payment system with your customer or client, you’ll need:

  1. First name
  2. Last name
  3. The type of banking account
  4. Bank account number
  5. Routing number

That’s it! Some processors may require additional information, but that’s all you’ll need to ask of your customers.

Why some ACH payments bounce or fail

When an ACH payment fails, you’ll get a specific code for why it did and when from your bank. Here are the most common of those codes:

R01 – Insufficient funds

The customer just doesn’t have enough money in the associated account. At this point, you should notify the customer and establish that service will be discontinued unless the issue is resolved OR procure a different account for payment.

R02 – Bank account closed

R02 fires when the account you had ACH payments set up with no longer exists or is closed. This is common when consumers just change banks and don’t update their payment information. Just reach back out and ask them to update their information.

R03 – No bank account/unable to locate account

This usually occurs before the ACH relationship is set up — the system can’t find the account the user is referencing with their information.

R29 – Reject

This code fires when the customer’s bank has a preventative measure against ACH payments. You’ll need them to deliver your ACH originator ID to their bank and ask them to enable ACH payment privileges.

R29 could also open you up to penalties tied to rejected ACH payments. Make sure you resolve any issues as quickly as possible and only establish ACH relationships with customers you can count on.

The bottom line

ACH payments are an obvious choice for many businesses — they’re cheaper, more secure, and getting faster by the day. And since it’s more convenient for customers as well, signing up customers is easy and comfortable if you sell subscriptions or recurring services.

Just make sure you use a good processor that respects NACHA and keeps up with their changing rules!

Tidal Commerce loves to work with smart, driven business owners. As long as you want to grow your business and appreciate transparency and honesty, you’ll fit right in.

Think you’re in that camp and want to use ACH payments in your business?

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