What is ACH?
Globally, this method is referred to as Electronic Funds Transfer (EFT), Pre-Authorized Debit, Direct Debit or BACS (Bankers Authorized Clearing System - in the UK). In all cases, it involved the direct, domestic transfer of a single currency - money does not cross borders and the currency does not change. For the purposes of this explanation, we will refer to “ACH”.
ACH is a form of electronic funds transfer (EFT) used in the US. Also known as “direct payments,” ACH payments are a way to transfer money from one bank account to another without using paper checks, credit card networks, wire transfers, or cash.
These funds travel through the ACH (Automated Clearing House) network, the US dollar-based, low value domestic bank transfer method, which connects thousands of financial institutions across the nation. When a customer pays you through ACH, that payment will show up in your bank account as a direct deposit or direct payment.
To pay with ACH, the customer needs to authorize the biller to directly withdraw funds from his account. Consumers do this frequently with bills like utilities. Typically, the customer provides the bank account and routing numbers to his checking account, and gives the biller authorization by signing an agreement allowing for funds to be withdrawn.
Two types of payment can be set up with ACH:
- Automatic payments: Automatic recurring payments are pulled from an account every time the bill is due. For example, a utility company may automatically charge for its monthly invoices. Since the consumer has agreed to this arrangement, he need not take any action on the bill and it is automatically paid on the due date.
- On-demand payments: The link between a biller and a customer’s bank account can be set up without authorizing automatic payments. This gives the customer control over when funds are transmitted, as they have to be approved each time.
Should you offer ACH to your customers?
The main benefit of ACH is convenience, especially if your invoices are recurring. Customers who set up payment by ACH and allow for the payment to be automatically withdrawn when due have a much higher rate of on-time payments, and this allows you to more accurately forecast cash flow. Other benefits include:
- No need to wait for postal mail service or risk lost mail
- Easy tracking of payments for you and your customers since it’s on bank statements
- Customers are likely to accept electronic invoicing - faster, easier delivery of invoices
- Reduces the risk of fraud
- Lower cost than credit card and debit card payments
- Automated payments reduces the risk of human error
- New rules are being introduced for same-day ACH payment processing (typically it’s a 3-5 day window)
Environmentally friendly (no paper, no fuel costs for mail delivery, no waste)
Challenges with ACH
While there are clear benefits to ACH payments, there are a few challenges a business faces when they employ this method.
First, there is a character limit on ACH remittances, which means a customer paying multiple invoices often only references a few of them. It is then up to the cash applicator to ascertain, with incomplete information, how to apply the cash. This can result in misapplication and is an inefficient, manual effort.
Second, often a company paying with ACH will send a separate remittance, usually to an assigned AR inbox. This means the separate remittance and the payment need to be tied together, which can result in both errors and delays as this is also a highly manual effort.
While ACH is considered one of the more secure ways to transfer funds, it’s still a complex network of originators and receivers connected by layers of banking and intermediaries. Transactions begin with the originator, who sends the activity to its bank. The bank then activates an operator to sort that transaction and thousands of others into the varying payment pathways that eventually direct the funds to the appropriate receiver, which records the activity in the customer’s account. Each element of the system requires a security portal, and it is at the point of these security portals that most challenges arise.
A few best practices to implement when accessing ACH payment processing are:
Encryption: Encryption hides the information from the originator. Simple encryption includes an algorithm to scramble the data, and a key that un-encrypts it when it arrives at the assigned receiver. Encryption is required for most merchants, as without it the risk of breaches and data thefts could quickly put them out of business.
Authentication: Authentication of participants in the transaction, at both the beginning and the end, can protect all parties. This process means verifying the sender as someone who has valid access to the account being accessed as well as ensuring that the receiver is a real-world entity, and the accurate target of the funds being transferred.
Multi-factor authorization: Authorization can be as simple as verifying an identity through a photo ID, however, multi-factor authorization has higher success at deterring fraud. Common multi-factor authentication processes include requiring a password or pin, responses to security questions, fingerprint or face ID, and texted security codes.
What ACH isn’t
How is ACH different from other forms of electronic payment?
ACH payments vs. debit cards or credit cards: Even though both ACH and debit card transactions pull funds from a customer’s bank account, they do so through different means. Debit and credit card transactions run electronically through a payment processor, who connects to the issuing bank. There are higher fees involved with debit and credit card transactions because in addition to the payment processor fees, there are interchange fees and assessment fees that go to the issuing bank and card payment network.
ACH payments vs. wire transfers: A wire transfer is handled by two individual banks who work directly to verify funds and complete the transaction. Typically, the sender’s bank and the receiver’s bank charged a fee for the transaction—it’s not uncommon to see charges between $10 and $35 per transaction, from both the sending and receiving bank. ACH transactions, on the other hand, go through the Automated Clearing House, which is a network of financial institutions. Instead of two banks having to directly connect to move funds between each other, they can simply add the ACH payment to the flow of payments already moving through the ACH network. ACH batches and automates the flow of payments between financial institutions, which translates to cost savings.