For over several decades, ACH, which stands for Automated Clearing House, has grown to become one of the largest, safest and most efficient payments systems in the world of banking. Each year, transactions worth trillions of dollars are handled by the network.
Also, the transactions are so cost-effective and the settling of payments being very quick made ACH payments system the preferred ‘go-to’ option for businesses, regardless of their size and industry.
It is no doubt that as a business owner, you must have heard of ACH payments. However, for those who might not be familiar with what exactly it is and how it works, we, at PlanGrip, will guide you through with an overview, types of transactions handled and working of this payment processing system.
Let us first understand what is the ACH payments system in a little more detail. ACH payments are a form of electronic bank transaction which is supposedly made using a network called an Automated Clearing House (ACH).
The technical definition thus is that the ACH network is a system of computers that communicate with each other in order to make and receive payments. Therefore, for this to work, every transaction consists of two computers – one at the sending end, which is used to send a request for payment and another at the receiving end, which is used for accepting the request.
Businesses in the US use ACH payments for paying bills, wages, mortgages and loans, and for making direct deposits. Electronic payments made through the ACH network must follow guidelines provided by the National Automated Clearing House Association (NACHA).
The ACH payments system is so widespread that many individuals do not realize that they are actually using this service in their day-to-day lives. For instance, if you have ever paid a friend on Venmo, purchased an item through PayPal, paid your cable bill online, or if your employer deposited your wages directly into your bank account, then you have participated in an ACH payment as a consumer.
However, you might not have understood the intricacies of ACH payment processing, especially as it pertains to your small business. Accepting ACH deposits at your business essentially means that you allow your clients or customers to electronically transfer funds from their bank accounts into your business bank account. In other words, ACH payments are an alternative to paying with cash, credit, debit, or cheques (checks).
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Traditional banks, merchant account providers, all-in-one payment processors such as Square or PayPal, dedicated ACH processing companies and even certain accounting software companies might all be capable of handling ACH payment processing for businesses. According to NACHA, ACH debits are certainly a mainstream method of payment, too.
Direct deposits are initiated by the payer to send funds directly to a receiving account. For instance, to pay wages to an employee. Thus, indirect ACH deposit transactions, consumers, businesses, or other entities can push money into other bank accounts, whether that is between their own accounts, between individuals (via Venmo, for instance), to pay suppliers, or when employers deposit payroll in their employees’ bank accounts.
Direct payments are initiated by the recipient to request funds. For instance, to collect payment for recurring bills. In other words, the direct payments work the other way around from direct deposits, rather than pushing money into accounts, in this scenario, individuals, businesses, or other entities pull money from accounts.
If you have set up recurring payments with your service providers, for instance, that company will automatically pull funds from your bank account on a monthly basis.
Things what you need to know about ACH payments and how the process works for small businesses that choose to handle ACH debits as a method of payment for their products or services.
An ACH transaction generally consists of a data file containing information about the desired payment. Processing a transaction consists of sending that file to the originator’s bank, then to the clearinghouse and finally to the recipient’s bank, where the funds transfer to the receiving account.
Essentially, anytime you have made an online payment or been paid electronically, you have participated in an example of an ACH payment. But as a reminder, below are some of the more common scenarios in which ACH payments use:
An individual pays another individual electronically, via their bank, Venmo, PayPal, Zelle, or a similar platform.
Consumer pays their service providers (like cable and gas companies), either manually or through recurring payments.
An employer deposits payroll into employees’ bank accounts.
An individual moves funds between his/her own bank account.
An individual receives a tax refund via direct deposit rather than a paper cheque (check).
Businesses transfer funds between themselves.
Transferring of funds via ACH payment processing is relatively simple, but there are a few major players. Here is a step-by-step look at how ACH transactions occur:
Step 1: ACH Payment Initiation
Originator (like a bank, an individual, a business, or another entity) initiates an ACH transaction. This can be a direct payment or a direct deposit.
Step 2: Originating Bank Submits ACH Entry
The originator’s bank or a payment processor, known as the Originating Depository Financial Institution (ODFI) submits the ACH entry.
Step 3: Originating Bank Sends ACH Entry Batch
The ODFI sends their ACH entries in batches, according to their predetermined schedule, to an ACH Operator.
Step 4: ACH Operator Sorts ACH Entries
The ACH Operator within the ACH network sorts through the batches of ACH entries to determine whether they are deposits or payments.
Step 5: ACH Operator Sends ACH Entries
After sorting through the batches of ACH entries, the ACH Operator transmits them to their respective Receiving Depository Financial Institutions (RDFI).
Step 6: Receiving Bank Ensures Sufficient Funds
If ACH transaction is an ACH deposit and involves pulling funds, then the receiving bank first needs to ensure that there are sufficient funds in the ODFI.
Step 7: Receiving Bank Debits or Credits Originating Bank
Depending on whether the transaction is a deposit or a payment, the RDFI will debit or credit the receiver’s bank account.
Generally speaking, ACH payments are more efficient than the card, wire transfer, check or cash payments. Because ACH transaction passes through a single clearinghouse without a lot of intermediate steps, they offer lower transaction costs, better security and more convenience than other payment methods.
ACH payments are best for their low transaction cost compared to credit card and wire payments. Whereas credit card transactions cost around 2% of the payment amount, and wire transactions cost $10-35 each, ACH payments cost under $1, regardless of the amount paid.
Although wire transfers are quick, they are irreversible. During a wire transfer, there is no way of verifying the sender or recipient’s identity. Since these payments cannot be reversed, it is easy to pull off a wire transfer scam using fake identities. With ACH, payments are reversible and users get authentication to prevent fraud.
The financial transaction comes with a concern about how secure it is. This is because payment errors such as bounced checks, misused credit card information, wire transfers sent to the wrong recipients, and cash theft can do serious damage to your business.
ACH payments provide secure payments by allowing direct transactions between two parties with no mediator in the middle. Unlike with other electronic payment methods, you can set up a recurring payment without asking your customer to provide their bank account information every time. By sending private information less frequently, ACH reduces the chances of fraud or erroneous payments.
ACH and recurring payments go well together. Here are a few reasons why:
Recurring ACH payments allow you to spend less time on each transaction. When you and your customer set up a recurring payment, every transaction made after that is automated.
Your customer does not need to worry about missing a payment.
Likewise, you do not need to chase late payments or remind customers to pay.
A common reason for customer churn is payment failure. Payments made with ACH have lower failure rates than those made with credit cards because credit cards have the possibility of expiring. Since ACH payments make directly from bank account to bank account, they reduce the chances of payment failure and therefore customer churn.
The ACH network is a secure and economical way for your business to send and receive funds, especially if you handle recurring payments.
Its simplicity and ability to reduce customer churn make it an appealing alternative to conventional payment methods like cash, check card, and wire transfer. If you want the business to have the best possible footing, then switching to ACH payments is a good move.
Accepting ACH payments are simple, you just need to work with a provider with an ACH service that can handle the process for you. Deciding to take advantage of your provider’s ACH capabilities may not be such a simple process.
You will need to consider the cost. The ACH transaction fees are much lower than credit or debit card transaction fees, payment processors will still charge you for ACH payments.
Typically, you will have to pay less for more ACH transactions and more for fewer ACH transactions. If you expect that only a few of your customers will take advantage of ACH payments then the cost might outweigh the benefits.