Handing your roommate a $10 bill (or writing them a check) is a reasonably efficient way to settle a single debt. When your transactions number in the hundreds, however—and your debtors and credits are spread across the United States—paper checks become a much less efficient way to receive and send money. The ACH network solves this problem by facilitating electronic transfers between financial institutions.
What is the Automated Clearing House (ACH)?
The Automated Clearing House (ACH) is an electronic network for processing electronic payments between banks. The ACH network is maintained by an organization called NACHA, or the National Automated Clearing House Association, a 501(c)(6) not-for-profit association connected to some 11,000 different financial institutions.
The need for NACHA was identified in 1968 when a group of bankers in California noted the increasing volume of paper checks they were handling and processing. These bankers organized the special committee on paperless entries, or SCOPE, and, in 1972, formed the first ACH organization in California to handle electronic payment processing. NACHA followed in 1974.
NACHA manages everything pertaining to the maintenance, development, and administration of the ACH network, which has become the primary mechanism for handling financial transactions electronically in the United States. Every year, it facilitates the payment of billions of dollars pertaining to business, government, and consumer needs.
How does the ACH work?
The Automated Clearing House network serves as an intermediary between financial institutions—allowing banks, businesses, and institutions to send money electronically. The ACH network organizes and processes a type of electronic funds transfer known as an ACH transfer.
Here’s an example of how a direct deposit payment process using ACH works.
- The originating party (in this case, the employer) initiates a payment, like its employee’s biweekly paychecks.
- The originator’s bank (also known as ODFI, short for originating depository financial institution) batches the transaction along with other ACH transfers. These batched transactions are sent out at regular intervals during the business day.
- An ACH operator (either the Federal Reserve or the Electronic Payments Network) receives the batched transactions, sorts them, and submits the transactions to the receiving depository financial institution (RDFI).
- The receiving bank account processes the transaction and credits the receiving account (that of the employee).
All ACH transfers are categorized as either credit or debit transactions, with the classification being determined by the action of the originating party. Direct deposit, for example, is considered a credit transaction because the originating party is moving money from their account to the recipient’s bank account, resulting in a debit from the originating account and a credit to the receiving account.
How much does it cost to use and accept ACH payments?
ACH payment fees can be calculated in a number of ways—either as a flat fee per transaction, as a percentage of a transaction, or as a monthly cost. If you choose to accept ACH payments directly, your bank will determine the fees owed. Transfers such as bill payments, payroll direct deposits, and direct payments are often free of charge.
Many business owners also choose to work with third-party payment processors (such as PayPal, Stripe, Square, or others) to process business-to-business and business-to-consumer transactions. In this case, the third-party payment processor determines the cost of the transaction, with typical ACH transfer fees ranging from 0.8% to 1.5% of total transaction cost.
Advantages of the ACH network
One advantage of sending and accepting ACH payments is cost savings. Using ACH transfers to receive and send money allows companies to avoid paying credit card transaction fees, which can total up to 2.5% of the total transaction value.
On a $10,000 sale, that’s $250—and because sales amounts cover operating costs and cost of goods sold, this fee can significantly eat into your profit margin. If your net profit on a $10,000 sale is $3,000, for example, a 2.5% credit card fee reduces your profit by 8.3%.
ACH payments offer security advantages over both paper checks and cash. Checks can go missing in the mail, and large amounts of cash require advanced security measures to discourage theft—think security guards and armored trucks.
Electronic payments are less vulnerable, and ACH payments provide an additional advantage over instant transfers: their one-to-three-day processing time provides a buffer during which businesses can stop payment if fraud is suspected or an error is identified.
Electronic processing of ACH payments makes it easy to set up recurring payments to vendors or employees, cutting down on your administrative burden and reducing operating costs. Customers and employees also appreciate the ease of ACH payments.
Disadvantages of the ACH Network
Because ACH transfers are processed in batches, direct ACH payments are not processed instantly. It can take one to three business days for a transfer to appear in a recipient’s bank account once it is initiated. Some banks also allow for same-day ACH transfers, which may be available for an additional fee. Note, however, that processing cutoff times may result in same-day transfers processing during the next business day.
Some third-party processors allow for instant ACH transfers by crediting money to a receiving account immediately within the processing app, then reconciling the accounts through the ACH transaction process at a later date. These processors may also have “instant” transfer options available.
No international payments
ACH payments can only be deposited into United States bank accounts. International money transfers require businesses to use wire transfers or other methods such as mailing a paper check or initiating a transfer via a third-party payment processor.
Some banks impose limits daily, weekly, monthly, or per-transaction limits on the amount of money that can be sent by ACH. Check with your bank to make sure that its policies support the kind of transfers you need to support your business operations.
The business world moves fast—and writing, mailing, and cashing a paper check is a frustratingly analog process. A world where you can pay your subway fare with a tap of your credit card and purchase your groceries through fingerprint recognition is one where efficiency is key—for both your business and your customers.
ACH transfers offer increased security and convenience for both creditors and recipients at a relatively low cost. Your bank (or a third-party processor) can make sending and receiving payments an efficient and low-cost aspect of your business operations.