What is ACH and how does it work?

What is ACH and how does it work?

ACH (Automated Clearing House) is a payment system used by banks to transfer money between accounts electronically. ACH is a widely-used payment method in the United States. It has become increasingly popular over the years due to its convenience and speed. In fact, according to the National Automated Clearing House Association (NACHA) “2022 was the 10th consecutive year in which the total value of ACH payments increased by at least $1 trillion, and the ACH Network has seen growth in nearly every payment category year-over-year.” But understanding what ACH means and how it works can be complex.

Despite its growth and ubiquitous use in modern commerce – accounting for $30bn in total payments for 2022 – there can still be a lot of confusion around the multitude of ACH types and terminology in use today.

We will discuss the various aspects of ACH, including how it works, its meaning, transaction types, payment methods, and differences from other payment systems like wire transfers and EFT in this blog. Here’s a list of common terms and methodologies, and what they mean in layman’s terms:

How does ACH work?


The person or business initiating the transfer (known as the originator) obtains the necessary authorization from the recipient to initiate the transaction. Authorizations are obtained through various means such as a signed authorization form or online authorization.


The originator initiates the transaction by submitting an electronic file to their bank. Information about the transaction, including the recipient’s bank account information, amount to be transferred, and any additional information required is contained in the file.


The originator’s bank forwards the transaction to the operator, which is responsible for routing the transaction to the recipient’s bank.


The recipient’s bank receives the transaction and processes it, which involves verifying the account information, ensuring sufficient funds are available, and executing the transfer.


The operator settles the transaction by transferring the funds from the originator’s bank account to the recipient’s bank account. This process typically takes 1-2 business days to complete.


Finally, the originator and recipient are notified of the transaction through their respective banks’ account statements or online banking platforms.


The payments industry can often be overwhelming with its use of initialisms and acronyms to abbreviate the methods, institutions and mechanisms that make it all work. Here we’ll quickly detail the terms typically associated with ACH in to shed light on how this complex industry functions.

  • ACH Credit: Commonly used for direct deposits and payments and government payments such as tax refunds and social security benefits.
  • ACH Debit: Commonly used for automatic bill payments and other recurring payments.
  • ACH Deposit: Commonly used for direct deposits of payroll, social security benefits, and tax refunds.
  • ACH Payment: A payment type processed specifically through the Automated Clearing House network. Commonly used for direct deposits, bill payments, payroll, and other recurring payments.
  • ACH Bank Transfer: An electronic transfer of funds between two bank accounts. A Bank Transfer is processed through the Automated Clearing House network and is commonly used for recurring payments, such as direct deposits, bill payments, and payroll.
  • ACH Number: ACH number, also known as a routing number or ABA number, is a unique identifier assigned to a bank or financial institution. This number identifies the bank or institution when processing transactions.
  • Same-Day ACH: Same-Day ACH is a service that allows transactions to be processed and settled same day. Prior to the introduction of Same-Day, transactions typically took 1-2 business days to process and settle. Used for a variety of purposes, such as expedited payroll processing, emergency payments, and faster bill payments. Also used for consumer payments, such as expedited payments for online purchases or donations.
  • Return Item: A transaction returned because of an issue such as insufficient funds or an invalid account number.

Who is a Tier 1 Processor and Why a Fed Terminal is so Important

  • Tier 1 Processor: A high-volume payment processing company that provides direct access to the ACH network. These companies are typically large well-established financial institutions or tech companies. These companies that have the resources and infrastructure to process millions of transactions per day. They provide a range of processing services, including transaction routing, settlement, and reporting, as well as fraud prevention and risk management tools.
  • Fed Terminal: A type of electronic payment terminal that allows merchants to process ACH payments directly from a customer’s bank account. Businesses that have recurring payments or payments with high transaction values typically use fed terminals. Examples of businesses that use fed terminals include utility companies, insurance providers, and government agencies.

Common abbreviations

  • ACH: Automated Clearing House – A “clearing house” is a financial institution. It acts as an intermediary between buyers and sellers of financial instruments, such as money, stocks, bonds, futures, and options. The main function of a clearing house is to reduce risk and facilitate smooth transactions in financial markets.
  • NACHA: NACHA stands for “National Automated Clearing House Association”. It is a non-profit organization that oversees the ACH Network in the United States. NACHA develops and enforces the rules and guidelines for the network. It also provides education and support to its members who process payments via the network, which includes financial institutions, businesses, and government agencies.
  • AAP: The Automated Accounting Participant is a financial institution authorized to perform automated accounting functions and has met certain requirements to participate in the ACH network.
  • ODFI: Originating Depository Financial Institution, which is the financial institution that initiates a transaction on behalf of an originator.
  • RDFI: Receiving Depository Financial Institution, which is the financial institution that receives a transaction on behalf of a receiver.

ACH vs. other digital payment methods

A multitude of digital payment methods are available in the B2B and B2C spaces today, which often overlap with ACH. Digital payment methods most commonly confused with ACH and how they primarily differ are listed below:

  • ACH vs. EFT: ACH is a specific type of EFT that is used in the United States for batch processing of financial transactions. EFT is a broader term that encompasses various electronic payment methods.
  • ACH vs. Direct Debit: Direct debit allows businesses to automatically withdraw funds from a customer’s bank account to pay for products or services. The way payments are initiated is a key difference between these two transaction methods. The recipient initiates the payment with ACH, while with Direct Debit the payment is initiated by the payer.
  • ACH vs. Wire Transfers: Wire transfers are electronic transfers of funds from one bank account to another. Wire transfers, usually processed in real-time, is a faster payment method (unless you’re using Same-Day). However, they are more expensive and often require more information from the sender.
  • ACH vs. Electronic Check Conversion: This payment method allows merchants to convert paper checks into electronic transactions. The customer provides the merchant with a check, and the merchant processes the payment electronically.
  • ACH vs. Online Bill Payment: This method allows customers to pay bills online through a bank’s website or a third-party payment processor. Online bill payment is similar to ACH in that it allows customers to make payments electronically, but it may not be as fast or secure.


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