In the procure-to-pay process, sellers often have limited control over when and how they receive payments for their goods or services. This uncertainty can impact cash flow, hinder forecasting, and create administrative burdens. However, with direct debit as a payment method, sellers gain a predictable and efficient way to collect payments directly from customers’ accounts.
This article delves into the essentials of direct debit, covering key questions such as: What is a direct debit payment? How does direct debit work? How can it benefit your business?
What is direct debit?
A direct debit — sometimes referred to as a bank debit or an automated clearing house (ACH) debit in the United States — is a cashless transaction that is pre-authorized by the party making the payment but initiated by the party receiving the payment. The relevant funds are transferred directly from the customer’s bank account to that of the seller or service provider. The terms for the underlying authorization, recorded in a document known as a “mandate,” can be somewhat flexible, designating a specific due date and amount or granting the receiving party the ability to set those terms on an ad hoc basis within defined criteria.
What can direct debit be used for?
Typically, direct debits are set up to support autopay functions for recurring costs. However, this transfer method can be used for one-off transactions as well. Typically, direct debit payments will be for:
- Utility bills: Expenses such as power, gas, or water are commonly charged on a consumption basis, leading to variable costs, and direct debit ensures that these essential services remain paid and active.
- Rent or mortgage: Another critical expense, these payments benefit from set costs, making it much easier to create the initial mandate.
- Subscriptions or memberships: Whether assessed monthly, annually, or along some other interval, direct debit can keep subscription fees from slipping through the cracks.
- Loans: Direct debits are a common method for paying off personal, student, or car loans. They guarantee that payments are made on time without manual intervention.
- Installments: Some businesses — particularly those with long contract periods or large upfront costs — allow you to use direct debit to divide up your payments while limiting their risk.
How does direct debit work?
- A buyer purchases a (typically recurring) good or service that requires ongoing payments.
- The buyer sets up a mandate that authorizes the seller to collect these ongoing payments.
- At the appointed time, the seller initiates the direct debit transaction by asking their bank or some other payment processor to collect the relevant funds. As part of this request, the seller provides documentation regarding the agreed-upon payment terms and the buyer’s banking information.
- The seller’s bank or payment processor verifies the authenticity of the direct debit collection, typically by confirming with the buyer’s bank, which may or may not require additional term details from the buyer.
- Once verified, the buyer’s bank transfers the relevant funds to the seller’s bank account, commonly via an ACH payment in the United States or via a single euro payments area (SEPA) transaction in the European Union (EU).
How does direct debit differ from ACH credit?
Sometimes referred to as ACH debits, direct debits in the U.S. are commonly confused with ACH credits, a similar transaction type that also uses the ACH network. However, while ACH debits are initiated by the party receiving the funds, ACH credits are initiated by the payer. To put it more succinctly, ACH debits are pull payments, while ACH credits are push payments.
In addition, while ACH debits are typically used for recurring transactions, ACH credits are more commonly tied to single, one-off exchanges.
| Direct debit | ACH credit |
Initiator | The seller | The buyer |
Uses | Recurring charges (e.g., utility bills, mortgages, subscriptions) | One-off charges (e.g., tax refunds, individual purchases, payroll) |
Authorization | Occurs before the payment request | Occurs simultaneously with the initiated payment |
Timing | Set schedule | Ad hoc |
Important direct debit rules to know
- Direct debit guarantee: Some U.S. states and the U.K. have in place legal protections, typically referred to as a direct debit guarantee, that require immediate refunds be made available for payments taken in error or those that do not align with the established mandate.
- Documentation: Sellers maintain transaction records, mandates, and payment instructions.
- Payment instructions: Along with the payment request, the seller must provide the buyer (and their banking institution) with a clear description of the payment terms (e.g., amount, charge dates, frequency).
- Pre-authorization: Before a transaction can be initiated, a documented mandate, whether in electronic or paper form, must be in place.
- Settlement: Nacha, the non-profit, non-government organization that oversees the ACH network, aims to settle direct debits by the end of the next business day after the transaction occurs.
Benefits of direct debit
Reduced risk of non-payment
One of the key advantages offered by direct debit is the reduced risk of non-payment. Instead, as the seller, you have direct control over when you’ll receive funds since you initiated the transaction. Similarly, a customer can’t forget or overlook closing out an invoice as they’ve already authorized the charge and require no additional input.
Enhanced budgeting and cash flow control
Since your business now controls when payments occur — at least those covered by direct debit— you have much greater insight and control related to your overall cash flow. With this increased visibility, you can more effectively plan for the future and better respond to shifting situations.
Lower processing costs
When compared to the processing fees associated with common transaction types, ACH payments are highly competitive. For example, credit cards typically charge between 1.5% and 3.5% of the total transaction cost, and domestic wire transfers average anywhere between $15 and $30 per exchange. But users who use our A/R software—particularly with our Vendor Pay feature—can close out ACH payments at a flat rate of $1.00 per transaction.
At the same time, with a clearly defined payment schedule in place and your business initiating the transaction process, you can also eliminate the cost and labor tied to your dunning efforts, as these won’t be required.
Increased security and fraud detection
A direct debit guarantee may be in place depending on where the transaction occurs. As already noted, these rules offer comprehensive protections to your customers, safeguarding them against financial losses caused by error or fraud. Further, other legislation and banking policies typically provide similar protections for transactions in regions that still need these guarantees codified, although potentially without such immediate resolution.
How direct debit works at Invoiced
Convenience is the key to an effective direct debit process, and here at Invoiced (a Flywire company), we’ve designed our Accounts Receivable Automation platform to make direct debits as seamless as possible. Our integrated Autopay function handles these transactions and can also process credit card and general ACH payments.
- Before you can set up a direct debit, you will need an account with the GoCardless payment gateway. The setup process will allow you to create a new one if you do not have one yet.
- Access the platform’s Settings from the Invoiced dashboard to begin the setup process. Within this menu, you can configure a direct debit payment method.
- After the initial setup, when one of your customers next accesses their version of the Invoiced dashboard, they’ll be allowed to accept the direct debit mandate and add their bank account details.
- Going forward, after you enter a payment notice in the system, it will typically be resolved in 4-5 business days, and your customer will not need to respond to any other mandates.
Presently, our platform can support the following direct debit schemes:
- ACH in the United States
- Autogiro in Sweden
- Bacs in the United Kingdom
- Bulk Electronic Clearing System (BECS) in Australia
- Pre-authorized debit (PAD) in Canada
- SEPA in the European Union
Take control of your payments: Start using direct debit with Invoiced today
Whether accepting ACH debits, ACH credits, or any other transaction type, our Accounts Receivable Automation software can deliver an intuitive, straightforward payment experience for your customers. It’s built to readily accommodate even the most complex billing operations, offering you support for your AutoPay, subscription management, early payment discount, tax collection, short-pay, and scheduled payment functions.
Even global transactions, which embrace schemes outside of ACH, are relatively easy for our platform. We recently enhanced it to leverage Flywire’s global payment capabilities, making it easier to conduct business internationally in over 140 currencies. Schedule a demo today and unlock immediate value for your business and customers.
