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ACH: The Setup, the Process, and the Future

Paper Payment vs Electronic Payments

This article is republished with the express written permission of (TAPN) The Accounts Payable Network.

According to the National Automated Clearing House Association (NACHA), the number of electronic payments made through the ACH network increased by over 13 percent in 2007. NACHA statistical reports also show the number of corporate credit and debit (CCD) ACH transactions increased by over 150 million in 2007 compared to 2006.

ACH is clearly becoming more widely used each year, and with good reason. So what's driving the change, how can you get started, and what can you expect along the way? We'll cover that and more in this excellent article from TAPN (The Accounts Payable Network).



Getting Started

A company planning to begin making ACH payments must first establish an ACH relationship with its financial institution. In most banks, a Treasury Management Sales Officer will help educate the company about ACH and develop a product business plan. After identifying the company's businesses needs, the sales officer will perform a financial evaluation and begin the implementation process.

While evaluating the company, the bank sets unique credit risk limits and debit risk limits for that company.

"When I'm pricing my customers, I utilize a standard price," says Pete Lambert, Product Manager for RBC Centura Bank, "That client may or may not qualify for the standard price depending on the relationship and risk to the bank.

"For example, if I have a client that receives multiple services from the bank, I may reduce my standard pricing and 'relationship price' the client. Or the client may be very risky and I may choose not to give them the ACH due to the risk being greater than we will accept."

A contractual relationship must exist between the company and its originating financial institution. "A typical contract like that will point to the ACH rules and other regulations," says Mary S. O'Toole, Senior Vice President of ACH product management for Bank of America, "The company would need to agree to be in compliance with ACH rules on creating transactions for ACH processing. There are usually provisions about where the financial offsets take place and how to handle chargeback as well as provisions around data security and termination."

"We make sure that we provide information about specific ACH transaction types because the associated NACHA rules that govern ACH can be very detailed," says Alicia Treadway, an ACH Product Manager for SunTrust Bank, "So we try to provide a good level of education to all originators about their obligations with respect to the ACH rules."

To pay via ACH, a company needs either to create and transmit a data file to their bank, or use a data file solution provided by the bank to originate ACH payments. For companies with lower volume ACH activity, the bank typically provides a file solution through a secure Web interface. Companies with a larger ACH volume often choose to format their own ACH files in order to have a direct interface with the originating bank.

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Setting Up Vendors for ACH
Case studies: Tellabs Inc. and Goodyear Tire Co.

Tellabs Inc.

After making it a goal to convert vendors to ACH, Tellabs Inc., a global telecommunications supplier headquartered in Naperville, Ill., created an AP Team incentive program geared towards converting vendors.

"Tellabs' AP Team attacked the ACH challenge with communication after communication, internal and external," says Tellabs AP Manager, Steve Iannarone, "The key to changing a process is to over-communicate. We communicated internally and gained buy-in from business leadership and communicated externally to the vendors via form letters with checks, emails with payment method change forms, and during vendor requests for information."

Tellabs tracked vendor responses to their requests. As vendors converted to ACH, the company tracked metrics of the conversion to show the reduction of monthly checks issued and the increase in ACH payments sent. Tellabs used the metrics to renegotiate ACH fees with its bank based on increased volume.

Tellabs also offers ACH conversion during the new vendor setup process. A completed application on the vendor's organization's letterhead is required. "The application captures our vendors' bank information, bank contact and the person that authorized the conversion to ACH payments," says Iannarone, "This document is part of our Sarbanes-Oxley documentation for creating a new vendor where payments are going to be made via ACH."

Tellabs originates payments by creating a daily ACH payment run highlighting all invoices and credits due that day. After submitting the ACH file to the bank, Tellabs' ERP system sends an email to each ACH recipient that includes all the payment details.

Goodyear

Goodyear Tire & Rubber Company began using ACH payments in 2005. The company partnered with their primary bank and internal IT development team to assist in the implementation of their ACH process. It chose a third party EDI service provider to process their ACH transactions and to send the transactions to its bank. The bank confirms the transactions via the service provider, who then sends the confirmation to Goodyear's ERP system. Within the system, the AP department can see all the details of the transactions, including any rejections.

Goodyear offers ACH to any vendor that presents payment terms that are equal to or greater than Goodyear's established preferred payment terms. "Vendors don't automatically get put on ACH," says Jami Dunphy, AP manager for Goodyear, "They have to provide us with our preferred payment terms, or otherwise we will keep them on check. We're doing that to achieve our working capital and cash flow objectives."

After vendors submit their banking information on their company letterhead, Goodyear conducts a "one dollar test" to make sure the ACH process is successful. Once they receive confirmation on the test, they set the vendor as "live" in their master file.

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ACH Costs

Each financial institution determines their own pricing regarding ACH payments. A bank may charge a one-time implementation fee or there may be several specific initial costs that come from developing and testing the ACH process. Banks typically charge a monthly maintenance fee after implementing ACH.

The bank may charge to receive each ACH file created and transmitted by the company and may also charge a fee to process the files. They may or may not charge for addenda records (ACH records that contain information regarding the payment) transmitted, if any. Banks that offer Web-based ACH modules typically charge a fee to use the service, but not always.

Transaction volume also helps determine the cost structure. A bank typically charges X amount of dollars to originate X amount of ACH transactions. Discounts usually are associated with higher ACH volume. Smaller businesses with lower volume may receive bundled services for a fixed rate.

Typically, a bank charges for ACH returns or reversals. Transactions can be returned for many reasons, such as insufficient funds or debit blocks. Reversals occur when a company sends a file to its bank that contains erroneous items. The entire file may also have been sent in error. There is typically a one-time charge for having to reverse the transaction.

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Benefits of ACH

In general, it's cheaper to originate an ACH payment than it is to write a check. A check must be cut, mailed, processed in a lockbox, and deposited into the receiver's account through regular paper deposit methods. The check float time and clearance affect the availability of the funds. ACH transactions settle overnight and funds are available as soon as they hit the receiver's account. This provides more control over the inflow and outflow of cash within a company.

    

"Tellabs' current cost per month to issue payments, after converting a majority of payments to ACH, stands at $7,000."

"Currently, about 86 percent of payments issued by Tellabs are sent via ACH. This translates to a monthly savings of $14,000 a month for us."

Most of the costs associated with creating a check are eliminated with ACH. There are no manual processing costs, no costs for purchasing check stock, no envelope and postage costs, and there is no check clearing fee that some banks charge. Environmentally-conscious Tellabs Inc., who began using ACH payments for employee travel and entertainment expense reimbursements in December 1998, eliminated paper checks, envelopes, inks and emissions from the delivery of mail by using ACH.

The AP department at Tellabs began their project to convert vendors to ACH payments in October 2006. "At the time, the approximate cost of payments made on checks and ACH was $21,000 a month," says Iannarone, "Tellabs' current cost per month to issue payments, after converting a majority of payments to ACH, stands at $7,000. Currently, about 86 percent of payments issued by Tellabs are sent via ACH. This translates to a monthly savings of $14,000 a month for us."

It also offers time and resource savings to Tellabs' vendors because the vendors receive their payments the day they are due and it eliminates the need for them to continuously check on the payment status.

Goodyear benefits in similar ways. "Our biggest benefit is it helps us accomplish our terms objectives for certain suppliers, because they wanted to know the day they were going to get their money," says Dunphy. "With the check there's the float time and this way we were able to set up terms objectives with certain suppliers. Our biggest savings has been related to the extension of working capital and improved cash flow."

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ACH Risks

The financial risk of the originator is important in regards to ACH payments. Responsibility for determining whether or not an originator is financially sound falls on the originating bank. The originating bank assumes the risk for both ACH credit and debit transactions while the receiving bank incurs the risk of ACH credits only.

"Each bank is required by federal regulations to know their client and must complete the necessary checks and evaluations to comply with the know-your-customer requirements," says Lambert.

"Companies should be concerned with the operational risk," says Treadway, "It's very important for the company to have sound procedures and backup copies of ACH activity, ensure hardware and software doesn't fail, and try to maintain dual control where one individual is entering the payment or batch and a different individual is approving it."

Companies also need to be aware of the risk surrounding ACH authorization. "They need to make sure they are getting authorizations from their customers and their trading partners and they have processes in place to maintain those authorizations," says O'Toole, "They don't necessarily have to be written, but there has to be some traceable means to validate that the transactions were authorized."

Having the proper segregation of duties helps eliminate the risks involved in ACH transactions. "We have one person that sets up the vendor master file, another person that actually allows that to go into production in SAP," says Dunphy. "One person can enter the data, but it doesn't go live in the vendor master until a second person updates the information. With all of our segregation of duties and all of our SOX controls all the way through every step of the process, there's really no way that any one person can control two steps of the process."

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The Future for ACH

Tellabs goal for 2009 is to issue less than 100 checks once a month. "When Tellabs started its ACH project we issued an average of 450 checks a week," says Iannarone, "Currently, we are issuing checks twice a month and issue approximately 300 checks with the number continuing to dwindle." Tellabs also wants to continue to convert as many vendors as possible. The telecommunications company currently has over 800 active vendors receiving ACH payments.

    

"It is more efficient and has less chance of fraud than traditional checks..."

"The challenge is providing the remittance information with the ACH payment."

Goodyear plans to continue to offer ACH to its vendors but does not currently have plans to roll out ACH as a full-scale project. They have also been approached by several companies who have offered to set up ACH on their behalf, but Goodyear has yet to relinquish that control. "We want to control the vendor setup here," says Dunphy, "We want to do the on-boarding so we prefer to keep it in-house."

With the pace of the decline of check use still uncertain, Treadway believes that to accurately predict ACH growth, the industry must closely analyze the kinds of payments for which checks are still used. "Our challenge as an industry is to understand what the obstacles are to further allow ACH to grow," says Treadway, "That means coming up with creative ways to encourage and facilitate that electronic payment method."

"I think there is still lots of opportunity out there and still places where companies can achieve additional gains by substituting ACH for other payment types," says O'Toole, "There is still lots of opportunity around B2B payments between trading partners to further eliminate check payments and to go electronic. Again, it's capitalizing on trends to eliminate paper, to add efficiency, and to reduce overhead."

In Lambert's opinion, ACH will continue to grow as it becomes more economical for both the payor and the payee. "It is more efficient and has less chance of fraud than traditional checks," Lambert says, "The challenge is providing the remittance information with the ACH payment."

"I think ACH will need to address real time payments instead of the current batch process today. I believe once some of the barriers to ACH adoption are addressed than ACH will become the main method for B2B payments."

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