Woman making contactless ach payment

ACH Transactions: What Small Business Owners Need To Know

7 min read • Jan 17, 2021 • Barry Eitel

Even if you don’t know what ACH stands for, you’ve probably taken advantage of ACH transfers. If you’ve received your paycheck as direct deposit, sent a few bucks to a friend through Venmo, or paid your power bill online, you’ve used ACH.

ACH payments, which launched in 1974, have become such a common part of modern life that most people don’t even think about the mechanism that moves money in and out of their bank accounts.

For small businesses, understanding the basics of ACH is important on 2 fronts: you can pay others, like employees, with ACH, and you will likely be receiving payments electronically via ACH from other parties.

What Are Automated Clearing House (ACH) Transactions?

ACH is an acronym for “Automated Clearing House,” although the transactions will appear as ACH on bank statements. ACH is the method banks use to send money between accounts electronically.

Functionally, an ACH transaction is the electronic version of writing a check.

You might have known ACH as direct deposit, automatic billing, direct pay, or electronic checks, but they all use the same mechanism. Even shiny new Silicon Valley payment processors like PayPal, Square, and Venmo utilize the same ACH backbone that has been in place for over 45 years.

ACH is maintained, developed, and administered by the National Automated Clearing House Association (NACHA), a nonprofit funded by the financial companies that use ACH.

Used by millions of companies, the federal government, and all banks, the amount of money that moves through NACHA’s network is staggering. In 2019, some 24.7 billion payments were processed through the ACH network, a figure that has grown by more than 1 billion payments every year since 2014.

Not only are bill payments, salaries, and charitable gifts sent through ACH—Social Security, tax refunds, and other government benefits are deposited through ACH as well. Because of this, the federal government regulates the ACH network along with NACHA. NACHA estimated that the total value of all payments processed through ACH in 2019 was more than $55.8 trillion.

How Do ACH Payments Work?  

While the result of an ACH transaction is similar to writing a check, the process is different.

“ACH transactions are payment instructions to either debit or credit a deposit account,” according to the Federal Financial Institutions Examination Council. “They are batch-processed, value-dated electronic funds transfers between originating and receiving financial institutions. ACH transactions can either be credits, originated by the account holder sending funds (payer), or debits originated by the account holder receiving funds (payee).”

Before banks are contacted, authorization must be provided by the people involved. To receive a direct deposit as an employee, for example, you must sign an agreement with your employer. To pay a bill through ACH, you must authorize the transaction first. Oftentimes, you agree to the transaction once, then the direct deposits or automatic payments continue until you want them to stop.

In all ACH transactions, instructions are sent from an originating depository financial institution (ODFI) to a receiving depository financial institution (RDFI), which are usually both banks—sometimes even the same bank. The instructions from ODFI can be to either request or deliver money.

If an employee agrees to be paid through direct deposit, the employer’s bank is the ODFI in this instance. The employer shows the ODFI that the employee approved the transaction. The ODFI verifies this information and submits it to the ACH network. The ACH network routes the transaction to the RDFI of the employee. The RDFI makes the money available by crediting it to the employee’s bank account; at the same time, the ODFI is debiting money out of the employer’s bank account. Finally, the ACH network settles the transaction with both banks.  

The process sounds complicated, but because it is automated and electronic, it usually only takes 1 to 2 business days.

The system is basically the reverse for when a person is paying a company, like a consumer buying a product through Square or paying an insurance bill online. The ODFI would be the insurance company’s bank. Money would flow from the RDFI to the ODFI.

Difference Between ACH Payments and Wire Transfers

Wire transfers are another common way to send money between bank accounts, but these transactions are different from ACH payments in a number of ways. ACH payments only work within the United States, while wire transfers can be sent around the world. Wire transfers are immediate, which can be beneficial but has also made this method of payment popular with fraudsters. The cost of wiring money is typically quite high, too, compared with the relatively slight cost of ACH transfers.

You may also hear about Electronic Fund Transfers (EFTs), a blanket term that encompasses ACH payments, wire transfers, and pretty much any time money is exchanged electronically. All transactions that require a PIN code are an EFT, too, including using an ATM or paying with a debit card at a grocery store.

How To Pay Employees Using ACH

Most people experience ACH because they are paid through direct deposit—NACHA estimates 93% of American workers are paid this way.

To set up direct deposit for your employees, you should talk to your bank (i.e., the ODFI in this case) about what information they need and how much it will cost you.

Interested employees will agree to direct deposit and provide you with bank account and routing numbers. You then provide this information to the ODFI.

When payday comes, you submit your payment files to the ODFI. The ODFI then submits the transaction to the ACH network, which results in your employees receiving funds in their accounts soon after.

Depending on your agreement with your bank, you will be charged a flat fee or a percentage based on the amount moved through the ACH network.

How To Accept ACH Payments

To accept electronic payments for your goods or services, talk to your bank. Banks, credit card processors, and merchant account providers all offer various ACH services that vary in cost.

Especially if your operation is very small, new, or both, a popular way to accept ACH payments is Square, Venmo, or other mobile payment processors. Many businesses opt for these new payment processors because the fees are easy to understand, and it allows them to provide for customers who want to pay with plastic.

Why Use ACH?

The benefits of ACH are pretty clear: it’s fast, accurate, and relatively cheap. Because it is utilized by the US government and all the major banks, ACH is highly regulated and secure. Its popularity most likely stems from its automated and electronic nature—ACH sharply reduces the number of trips to the bank.

The fees range depending on your bank and how much money you process through ACH, but they are generally less expensive than what credit card processors charge. The low fees and overall convenience are major reasons why many businesses turn to ACH.

Additionally, ACH will make a huge dent in the amount of paper your business has to handle. Maintaining a check registry has long been a headache for most small business owners, while the automation and simplicity of ACH make payments much more streamlined. And no one has ever lost an ACH payment in the mail.   

The Drawbacks of ACH

By automating your payroll with ACH or enrolling in repeating payments, you may feel like you have less control of your cash outflows.

As a practice, you should always pay close attention to your bank accounts, even if you use ACH often. Automated payments can overdraw your account. You might also continue paying for services that you stop using if the payments are automatic and you stop paying attention.

Keep in mind that ACH payments can only happen between 2 bank accounts based in the US.

You must also consider the costs involved with ACH, even though they are typically lower than most other electronic payment options.

How Much Will It Cost?

The cost of using ACH transfers will depend on the financial institution, how much money you are transferring, and how regularly you transfer money. Banks may also charge rates that are different from mobile payment processors like Square, so you should do some research on what options are available to you.

Many ACH processors will charge a flat fee on every transaction, often between $0.25 and $0.75, although some processors charge as much as $1.50 per transaction. Other companies will charge a percentage on each transaction, usually between 0.5% and 1.5%.

ACH transfer fees are almost always lower than credit card processing fees, which can range from 1.5% to 4% on each transaction.

Is ACH Secure?

Because it is regulated by federal law, ACH transfers are one of the most secure ways to move money between bank accounts. To prevent fraud, NACHA requires a significant amount of identifying information from every person, business, and bank involved in the ACH process.

With such safety, speed, and convenience, it makes sense that so many small businesses adopt ACH processing into their banking practices.

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Barry Eitel

Barry Eitel has written about business and technology for eight years, including working as a staff writer for Intuit's Small Business Center and as the Business Editor for the Piedmont Post, a weekly newspaper covering the city of Piedmont, California.