Direct Debit 101 – Definition, How to Set It Up, and Its Benefits

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Small businesses in the UK are dearly in need of a reliable method of collecting payments. According to Bacs Payment Schemes Limited, a total of £14.2 billion worth of overdue payments were recorded in 2017 alone. Small and medium-sized enterprises (SMEs) make up almost 99% of the UK’s private business sector, and they’re uniquely vulnerable to problems stemming from late payments.

These unpaid invoices or late payments lead to a reduced cashflow, especially for businesses that provide recurring services. Prolonged cashflow issues in turn reduce these businesses’ working capital. This may cause serious debts and in the worst cases can even lead to bankruptcy. One effective way to combat cashflow issues is to provide a payment method that puts you in control — a method where you define when you get paid and how often. This is where Direct Debit comes in.

Direct Debit payments

What is Direct Debit payment?

The Direct Debit scheme is a popular payment method in the UK, in which customers authorise merchants or organisations to pull funds from their bank accounts. All Direct Debit payments are handled by Bacs (Bankers’ Automated Clearing Services), a central payment network that processes several different types of electronic payments. Direct Debit is usually used for making recurring payments like credit card bills, utility bills, instalment payments, rent, recurring retainer payments and subscriptions/memberships.

Advantages and benefits of Direct Debit for businesses

Let us look at some of the benefits that Direct Debit has to offer:

  • Helps you gain trust:  If you are an organisation or business taking payments through the Direct Debit scheme, you’ll be subjected to a thorough examination and monitored closely by banks. This constant scrutiny will make your business more transparent, enabling you to gain the trust of your customers.
  • Timely payments: Direct Debit allows business owners to get their payments on time, avoiding the risks and issues involved in late payments.
  • Better cashflow: With Direct Debit, payments for the services and products you offer are ensured. This leads to better cashflow. Better cashflow, in turn, leads to healthy working capital. With healthy capital, you can run your business smoothly.
  • Direct Debit Guarantee: The Direct Debit Guarantee is a set of protocols followed by banks that accept instructions to pay direct debits. These policies mainly favour the customers and ensure that customers are not liable for incorrect payments. Businesses using the Direct Debit scheme should be very careful about the time periods and amounts of the payments they initiate, because the Direct Debit Guarantee refunds the money immediately in the event of an error in payment.
  • Set-and-forget: The ease of set-up and the fact that the customer doesn’t need to go to the trouble of making payments each time, makes this payment method a must for all businesses in the UK. By providing the direct debit option for your customers, you make it easier for them to pay you with minimal intervention and this will be a huge plus for conducting business with you.
  • Lower failure rate: The overall failure rate at GoCardless for direct debit payments is 2.2%. This is very less when compared to the higher failure rates (5-18%) seen with credit card transactions.

How does Direct Debit work?

To set up Direct Debit, you must get an authorisation from your customer to pull funds from their accounts. Once you get the authorisation, you can take recurring payments from the customer’s account. You’ll be required to send a notice to the customer 10 working days before the actual transaction, informing them of the amount and the date. The only thing the customers need to do is to ensure that they have sufficient funds in their account.

Here’s an illustration explaining the bank-to-bank transfer in Direct Debit.

Direct Debit transaction

The business owner initiates the payment after setting up Direct Debit for their customer. The amount of payment and the date of the payment initiation should always match the advance notice you send to your customer. Funds from the customer’s bank account go through the Bacs cycle. For the first transaction, it takes five working days for the amount to settle in the business owner’s bank account, but subsequent transactions will be processed in three working days.

How to set up Direct Debit to start taking customer payments

To start taking funds from a customer’s account, you need to follow these steps.

  • Step 1: Prepare a mandate or authorisation document for your customer to sign. A mandate should contain the following details:
    • Account holder’s name
    • Bank/building society account number
    • Branch sort code
    • Bank/building society’s full postal address
    • Account holder’s contact details
    • Service User Number (SUN) of the originator (auto-filled)
    • Payment date
    • Payment amount

You can collect these details by sending your customer a hard copy of the form or online form to fill out and send back to you. You can also use a telephone call for collecting your customer’s details, but the script has to be approved by a bank.

  • Step 2: Get the mandate back from the customer and submit it to your bank. Most banks usually take about 4-6 days to activate a mandate.
  • Step 3: Once the mandate is active, you are required to notify your customers 10 days before initiating the actual payment. It takes 3-5 working days after the payment date for the funds to settle in your account. If you initiate a payment and it fails, you’ll receive a message from Bacs notifying you of the reason for failure. You will then need to speak to your customers to clarify the situation.

How to access Direct Debit

Bacs provides different options for accessing the direct debit scheme. You can select the most suitable method based on your organisation’s financial standing, administrative capabilities and volume of transactions.

There are two methods of accessing the Direct Debit scheme:

  • Direct access via a bank
  • Access via a Direct Debit bureau

Direct access via a bank:

Large businesses or organisations that can manage the Direct Debit process by themselves opt for the direct access method. The organisations using the direct access method are known as direct submitters. Direct access has the lowest transaction fees but the initial setup cost is very high. For businesses handling large volumes of recurring payments, the low transaction costs outweigh the initial overhead expenses.

The first step to become a direct submitter is to apply for a Service User Number (SUN). Obtaining a SUN is not a particularly swift or easy process — it can take months, and banks usually reject businesses that have a small turnover or don’t seem equipped enough to handle Direct Debit on their own. If your business meets the following criteria, then the bank might approve you and provide you with a SUN.

  • Revenue greater than £1 million (some banks even have a threshold of £10 million). Your business needs a huge turnover to even be considered for approval.
  • Well-equipped with both the workforce and the technical expertise required to handle the workload that comes with direct access.

If you get approved for a SUN, you will have to build a system in-house to collect, store and submit the necessary information to Bacs. Bacs approved direct debit management software provides an integrated platform for accessing a range of Direct Debit schemes.

Access via Direct Debit bureau:

If you don’t have the necessary turnover or just want to be free from all the extra work of handling Direct Debit in-house, you can use a Direct Debit bureau. Direct Debit bureaus are third-party organisations that handle direct debit payments and most of the work related to them on your behalf.

Traditional bureaus only handle the Bacs submission process, so you still have to collect the mandates yourself. The bureau procures your customers’ details from you and handles all the paperwork like Bacs submission and payment details.

When using a third-party bureau, you can use either your own SUN (Service User Number) or the bureau’s SUN to make payments. The best option is to use your own SUN, because only the name of your business is shown on your customer’s bank statements. But if you need the payments to start quickly and you don’t mind the bureau’s name on your customer’s transactions, you can opt for using the bureau’s SUN.

Depending on which bureau you choose, it might charge you for the setup of your account, for monthly usage, and for every transaction and submission. Some bureaus also charge a penalty for each failed payment. Traditional bureaus can be somewhat non-transparent about their costs, so you may want to use an online Direct Debit provider instead. Online Direct Debit providers generally offer better features at meagre costs for setup and transactions. Some online providers even send customer mandates for you. You just have to direct your customers to your online provider and they will take care of the rest.

Direct debit is a simple and sensible alternative that gives you complete control over your payments, including recurring payments. Its low failure rate and minimal need for manual intervention make it appealing to customers and businesses alike.

So if you are providing recurring services in the UK and are in search of the best payment method for your business, Direct Debit is an option that has potential to help you maintain a healthy cashflow.

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  1. Vinay Pratap

    Hi Mira
    The content looks very informative, could you please clear one of my doubt mentioned below?

    Is PSP and Direct debit berau ?

    • Mira Natarajan

      Hi Vinay,
      Most payment service providers (PSP) allow businesses to accept Direct Debit payments. I hope this answers your question, but if you’d like to know anything else please contact us at support@zohobooks.com. We’ll be happy to help.

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