How Does ACH Work?

Apr 28, 2022 by Kelsey Banerjee

While ACH has been around for decades, more and more businesses are shifting away from credit cards and bank wires in favor of this payment method. In 2021, same-day ACH grew by 74%, with B2B payments specifically being up 20.4%.

The fact is that businesses continue to find value in ACH payments for their domestic transactions.

What is ACH, and how does ACH work?

Short for Automated Clearing House, the ACH payment process has its roots in a common problem — check payments. A group of Californian bankers in 1968 disliked the ever-mounting stack of paper checks they needed to process. Feeling that the use of checks was growing too rapidly for banks to scale and that the volume of transfers would soon outpace their ability to process payments, they formed a special committee to research alternative methods of payment.

And they were hardly the only ones concerned. The American Bankers Association was researching different payment methods as well.

It wasn't long before the first ACH Association was born. In 1972, this California-based association handled the first local electronic payments. This payment method was so effective, scalable, and secure — at least compared to the flimsy paper check — that more and more associations began popping up. Finally, in 1974, these regional splinter groups combined to form the National Automated Clearing House Association (Nacha), a financial institution that would oversee all ACH payments.

ACH is so popular that it's still the number one way Americans get paid. Even 99% of Social Security benefits payments are made through the ACH network.

But how does ACH work, exactly?

Also known as direct payments or direct debit, ACH payments are a method to transfer funds without using paper checks, payment cards, wire transfers, or cash.

The payment process is fairly simple. Once a client decides to pay via ACH, the originating depository financial institution (ODFI), or the client's bank, will receive the ACH instructions.

This is sent to an ACH operator, who connects the client's bank to the receiving depository financial institution (RDFI) or your business's bank. Once the payment is approved at each level, the funds will be deposited into the receiver's bank account.

There are a few things that happen during this process. Most commonly known are the ACH Credit, or push transaction, and the ACH Debit, or pull. An ACH Credit transaction simply refers to the funds being pushed into the receiver's account. An ACH Debit transaction, meanwhile, refers to the funds being taken from the original account and deposited into the receiver's account.

Many transactions take 2-5 days to process.

What are the different types of ACH transactions?

There are two general B2B transaction types when it comes to ACH payments:

  1. Corporate Credit or Debit (CCD) — The most popular kind of transaction, a CCD entry is an ACH transfer used for regular payment processing, such as paying vendors or employees. In a CCD entry, a company account will originate a single or recurring ACH transaction.
  2. Corporate Trade Exchange (CTX) — Used for trading partner payments, a CTX transaction can also be either single or recurring payments.

What information is needed for an ACH transfer?

For an ACH transfer to work, your client will need some key information, including your:

  • Name
  • Routing/ABA number
  • Account number
  • Account Type
  • Transaction Amount

Given that an ACH payment is a domestic payment method for the United States, there's no need for a SWIFT or IBAN code.

What happens if an ACH payment is rejected?

If an ACH transaction doesn't go through, you will receive an error code that can be sent back to the client. The ACH error codes are:

  • R01 - Insufficient funds
  • R02 - Bank account is closed
  • R03 - Unable to locate the account
  • R04 - Reject

Most of these are self-explanatory except for the last code, R04 Reject. In this case, the customer will need to provide their bank with your ACH Originator ID or enable your business to make withdrawals from their account.

Why use ACH today?

There are several benefits to using the ACH network. Reasons to use ACH include:

  • Lower costs — Compared to credit card processing fees or wire transfers, ACH payment processing is incredibly low cost. Transactions can run between $0.20 to $1.50 per transaction. Comparing this to a $15 wire transfer or a 2.9% credit card fee makes it easy to see how organizations can save through ACH alone.
  • Faster payment processing — ACH payment processing can take up to 5 days, but it's common to see a transaction settled within 1 to 2 days. Furthermore, because your AR team doesn't have to deal with the hassles of paper checks or credit card reconciliation, they can reconcile payments faster.
  • Customer convenience — ACH deposits have the potential to be incredibly convenient for customers, who can use the recurring payment option to automate their process.
  • Security — Finally, ACH transfers are considerably more secure than a paper check or credit card. Unlike other modes of payment, the fraud rate for ACH is just 1.3%.

What are the cons of using ACH?

While ACH payments are preferable to other methods, they also have their flaws.

Since the technology and process haven’t changed since the 1970s, ACH payment processing is considered slow by today's standards. For example, even with the arrival of Same-Day ACH, a direct deposit may still take 3-5 days to clear. Furthermore, the process is drawn out by the fact that transactions may not be initiated until the next day due to cutoff timings.

ACH payments can also only be used with domestic transfers — so cross-border payments will require a different solution. There’s also a $25,000 cap that limits how much you can send at once.

In comparison to other payment methods, these cons are relatively inconsequential. And luckily, there are ways of improving the process.

ACH with modern payment gateways

The key to optimizing ACH payments — and increasing the amount of ACH payments you receive — is through a modern AR integration for your ERP system. The reasons are simple.

First, the right AR payment gateway is a flat fee based on your volume of transactions. This model can further reduce how much you may pay per ACH payment, but it also doesn't limit your payment options.

Next, these integrations usually help to automate the entire AR process. AR automation creates a stellar customer experience, which in turn lowers DSO, and the AR Team benefits from the ease of use and lack of manual data entry work.

Finally, certain features can encourage ACH payments and drive customers away from more costly payments. At Paystand, we call this "Zero-Fee." The concept is simple. Your organization shoulders the cost of the ACH payment, which is significantly less than other transactions, thus making it appear to be "free."

At the same time, you can use a convenience fee for other costlier methods to shift the burden to the payer. Combined, these two features can change customer behavior and shift more payments towards ACH.

But at Paystand, we do even more. Customers can also save their payment details, set up recurring payments, and pay multiple or partial invoices. We also issue an automated, certified receipt for auditability.

Get Paid with Paystand

ACH is by far one of the most attractive methods of payment to date. But it’s only a part of a larger AR strategy.

At Paystand, we know how important it is to provide a seamless customer experience without the hassles of rigid payment gateways or more manual entry. We believe that B2B payments should be as easy as Venmo.

That’s why we offer a user-friendly payment portal, automate the AR process, and offer enhanced analytics — to help you get paid faster.

Read our eBook to learn more about ACH payments and AR optimization.