Ultimate Guide on How Do ACH Payments Work
We’ve put together the ultimate go-to guide for learning how ACH payments work. Under each section, you will find in-depth answers to some of today’s most commonly asked questions relating to how do ACH payments work and how businesses can benefit from them.
1. What Is an ACH Payment?
An ACH payment uses the Automated Clearing House to process a payment electronically. Funds are removed from the originating account and transferred into the receiving account.
Sending money electronically comes with numerous advantages. Not only does it expedite the payment process, but it allows businesses to increase revenue by reducing payment processing expenses. ACH payments create faster authorizations and translate into simplified reporting.
An ACH payment involves several entities. You have the payer, the entity receiving funds, and at least two financial institutions: the Originating Depository Financial Institution (ODFI) and the Receiving Depository Financial Institution (RDFI).
2. What Happens During the ACH Payment Transaction?
When your business pays its suppliers with an ACH payment, a debit entry request will be sent by the ODFI (your bank account) to the RDFI. Your permission is required to have funds debited from your account. The ODFI and RDFI will then communicate with one another to ensure the requested funds are available. If they are, then the ACH payment process will continue. If there is a middleman involved — like an ACH operator — then communication will take place with this entity as well. When sufficient funds are not available, the ODFI will provide a return code, which will outline why the payment was not processed.
3. What Are the Types of ACH Transactions?
ACH transfers can occur in one of two ways: debit transactions or credit transactions. When a debit transaction occurs, this means money is getting pulled from your account to pay for goods or services, or perhaps to refund a customer for a returned item. When a credit transaction occurs, money is being pushed into your account, like when a customer pays you for a product.
ACH payments are processed according to various entry classes. If a payment isn’t processed correctly, you can dispute it. Please note, the entry classes listed below are only a few of the standard entry class codes used for processing ACH payments.
- Accounts receivable entry (ARC): When a payer makes an ACH payment using a check, it may be processed using the ARC entry class code.
- Customer initiated entry (CIE): Payers can use an online bill payment service provider or their online banking account to initiate a CIE payment.
- Prearranged payment and deposit entry (PDD): This entry class code can apply to direct deposit and pre-authorized bill payment debits. Many times, PDD payments are reoccurring.
- Re-presented check entry (RCK): This method is used to re-present a check to the Automated Clearing House in an attempt to process a check that has been returned due to insufficient funds.
- Internet-initiated entry (WEB): WEB ACH payments can be individual or reoccurring. Permission is given over the Internet by the payer to debit funds from his or her account.
4. What Happens if I Get a Return Code?
As there are numerous entry class codes for processing ACH payments, there are also many return codes. Any time you attempt to process an ACH payment and it does not go through, you will receive a return code, which provides helpful insight as to why the payment failed. The return code number correlates with the reason.
For example: If you receive a return code of R02, this means the account has been closed. Knowing this information allows you to determine whether you should try processing the payment again. With the R02 return code, there would be no sense in trying to submit payment from the provided account. In this instance, you would take measures to process the payment using a different method.
Five of the most common return codes are:
- R01: Insufficient funds
- R02: Account closed
- R03: Unable to locate the account
- R04: Invalid account number
- R20: Non-transaction account — the account entered has a restriction against it and cannot be used in an ACH transaction.
5. What Are the Different Applications for ACH Payments?
Any time money is being transferred between two entities, ACH payments can be of value. Whether it be receiving payments from customers or paying employees, ACH payments offer low transaction costs and can expedite the entire payment process.
Common reasons businesses often make use of ACH payment processing include:
- Accepting payments from customers
- Paying suppliers
- Paying freelancers
- Paying publishers
- Paying affiliates
6. ACH Payments Versus Wire Transfers
Wire transfers are well-known for their timeliness. Recipients can typically receive a wire transfer in less than 24 hours. ACH payments, however, take several days to process. Both types of transactions come with fees. Wire transfers are generally more expensive, with the transaction cost being anywhere from $40 to $60+. ACH payments, on the other hand, usually have a transaction cost ranging from 25 cents to $5.
Another key difference between wire transfers and ACH payments is the chargeback procedure. Funds exchanged between a wire transfer are verified when the transaction takes place, meaning there are no chargebacks. This type of payment also does not go through the Automated Clearing House like ACH payments. Since ACH payments are not verified during the initial processing phase, there is always a chance a chargeback could occur.
Automating an organization’s payables operation involves much more than just making payments. ACH payout processing can be enhanced by payee and supplier onboarding, refined invoice automation, and proactive fraudulent activity detection.
There are a ton of rules and regulations surrounding ACH payments. It is often best to team up with an ACH operator to ensure your ACH payment processing activities are in compliance with laws and regulations — and more importantly, to ensure your ACH framework is enhancing your operational activities, rather than hindering them.