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incoterms

About Incoterms

If you deal with international trade involving the shipping of products, then you must have heard of Incoterms. The number of parties involved in international trade calls for commonly accepted standards and rules that govern the accountability and responsibility of these parties. This situation is where the International Commerce Terms (Incoterms) comes to the fore.

These are the rules of trade, followed by two or more parties involved in multimodal and sea transport. Though it has been around since the 1920s, the latest version of 2010 contains as many as 11 terms. Right from EXW to DDP, the rules outline many terms in this set of standards. These terms help streamline the import-export and shipping process and makes clear what party is responsible for each part of the shipment.

What is the purpose of Incoterms?

The principal objective of incoterms is to set the boundary for responsibility and accountability between the different parties involved in international shipping and trade. Factors like taxation, delivery, storage, and duty charges need to be clearly defined so that there is no loss to any party because of a lack of clear understanding between other people in the workflow. It also denotes when the onus or accountability shifts from one party to another at different stages of the shipping process.

Without incoterms, the shipping process can result in miscommunications, misunderstandings, and potential frauds. Without well-defined responsibilities, considerable losses to any of the parties, including carriers, banks or freight forwarders may occur.

Why are incoterms useful?

The entire process of transporting goods from the seller to the buyer involves many touchpoints. Due to this fact, there is bound to be confusion between the parties involved in the shipment. To avoid misunderstandings, miscommunications, and to pinpoint correct attribution, it is in the best interest for the parties to adhere to a global standard like Incoterms.

Incoterms allow for a solid understanding between seller and buyer. Incoterms facilitate faster shipments and prevents financial loss due to damages or loss of cargo. All parties involved, including the freight carriers, customs brokers, insurers, and carriers use incoterms as a basis for shipments. Their universal application means that they need to be decomposed into logical categories for better conformity and understanding of each parties' responsibilities.

INCOTERM

EXW
FCA
FAS
FOB
CFR
CIF
CPT
CIP
DPU
DAP
DDP

Warehouse Services

Export Packing

Loading at Origin

Origin Inland Freight

Origin Port Charges

Origin Forwarder Fees

Ocean/Air Freight

Destination Port Charges

Customs Clearance

Customs GST/Duties

Final Destination Delivery

category:

What are these terms?

1 – Based on the type of shipping (defined later)

  1. Waterways transport make use of 4 terms - FAS, FOB, CFR, and CIF
  2. General forms of transportation make use of any of the 7 terms - EXW, FCA, CPT, CIP, DAT, DAP and DDP.

2 – Based on the point of delivery

Points of delivery are classified depending on how they move from the seller to the buyer. All similar starting alphabets are categorized together. To explain this better, let’s examine these terms carefully.

  • E terms (EXW): Here, the seller has minimum responsibility, as the product is still under the seller’s possession. In this stage, the seller will make the product ready to be dispatched for transportation to the buyer destination.
  • F terms (FCA, FOB, FAS): The seller dispatches the consignment to a pre-designated carrier for pickup and loading. The seller will be responsible for getting the goods transported to the carrier, but the buyer will take care of further transportation costs from the carrier and beyond.
  • C terms (CFR, CIF, CPT, CIP): These terms come into effect when the seller is required to pay for all charges and duties up to delivery at a foreign port.
  • D terms (DAT, DAP, DDP): These terms come into effect until the point of delivery to the buyer. This step means that all risks and charges are borne by the seller until the consignment reaches the buyer destination.

Where can you find more information on Incoterms?

The below definitions are for information only. Visit Trade.gov for additional information.

EXW (ExWorks)

ExWorks is when the seller receives order confirmation online and prepares the goods for dispatch. This phase may include printing the invoice and packaging the product. This step is typically carried out at the seller warehouse itself and has a low liability for the seller as he still has possession of the product.

FOB (Free on-Board Vessel) and FCA (Free Carrier)

The FCA phase signifies the shift of the product from the seller to the carrier. The seller's responsibility ends when they load the product in a truck and dispatches it to the port.

The FOB takes buyer responsibility further than loading it on the truck. Now, the seller has to also look after transportation to the port. He has to factor in unloading and customs clearance. He has to manage its safekeeping until the staff loads it to a vessel. The vessel may depart either the same day or after some days. Naturally, the seller's risk is more with FOB than FCA.

One interesting point of difference between the two 'F' terms – FOB will apply only to waterway or sea transportation. FCA will apply to any form of transportation

Another difference between the two terms is about the end of the liability. As we have already seen, the seller's liability in FOB is more than in FCA.

So, FOB = FCA + unloading + terminal handling charges + customs + loading to shipping vessel.

FAS (Free Alongside Ship)

The FAS incoterm is used with the seller is going to deliver their goods next to the buyer's vessel at the agreed to port. It should only be used for goods that are not placed in containers and/or shipped via inland waterways. Once the goods are delivered, the buyer assumes all costs and risks of loss of damage. If the seller selects the FAS incoterm, they are responsible for clearing the goods for export, unless explicit wording denotes that the buyer will be responsible for clearing in the contract.

CFR (Cost and Freight)

By selecting the CFR incoterm, the seller will pay for the export clearance and the freight costs to transport their goods the destination port. The seller pays for the carriage of the goods up to the named port of destination. Once the goods have been loaded onto the ship for transport, the risk of the goods transfers to the buyer. The seller is not responsible for delivery to the final destination or for insurance of the goods. If the buyer requires that the seller obtain their own insurance, consider the incoterm CIF for this transaction. CFR should only be used for goods that are not placed in containers and/or shipped via inland waterways.

CIF (Cost, Insurance and Freight)

CIF is similar to CFR except that the seller is responsible for obtaining their own insurance on the goods. By selecting CIF, the Institute Cargo Clauses (A) of the Institute of London Underwriters requires that the seller insure the goods for 110% of the contract value. Additionally, documentation such as bill of lading, invoice and insurance policy must be turned over to the buyer so that they may; if needed, assert any damage or claims of loss to the insurer. Once the documentation is turned over to the buyer, the buyer assumes responsibility for the goods. CIF should only be used for sea-freight and only for goods that are not placed in containers.

CIP (Carriage and Insurance Paid)

CIP is similar to CPT, except that the seller is required to purchase insurance on the cargo and can be used for any mode of transport. By selecting CIP, the Institute Cargo Clauses (A) of the Institute of London Underwriters requires that the seller insure the goods for 110% of the contract value. Using CIP will allow the buyer, seller, and any parties with an insurable interest to make a claim.

CPT (Carriage Paid to Destination)

If the seller is looking to transfer risk to the buyer early in the transit lifecycle then CPT should be used. Once the seller has transferred over the goods to the first carrier, the risk for the transport is transferred to the buyer at the place of the shipment in the country of export. The seller; however, is responsible for all origin costs to include any costs associated with export clearance, carriage freight costs including to the buyer's facilities or destination port agreed to by both parties.

For CPT, if insurance is required by the buyer, select CIP instead.

DAP (Delivered at Place 'named place of destination')

DAP or delivered at Place is used with the seller will deliver the goods at the buyer's place of unloading - the buyer is responsible for unloading. The seller's risk is transferred to the buyer once the goods reach the destination identified in the contract of delivery. Once the goods have arrived at the country of destination, the buyer is responsible for customs clearance of the goods. The seller is responsible for all export documentation, carriage and any terminal expenses at their cost and risk to clear the goods for export.

DDP (Delivered Duty Paid)

From the seller's perspective, this is the other extreme of EXW when it comes to risk-bearing and steps to handle. For DDP, the seller not only takes care of all formalities of the export of the product but also takes care of all import formalities in the buyer country. The risk for the seller is at the maximum in this arrangement. Right from transporting the cargo to the port, paperwork and export duties to unloading at the destination port, customs clearance, and import duties, all charges are borne only by the seller. Even after it is cleared in the destination country, his responsibility doesn't end there. He has the onus of transporting from the port to the buyer warehouse or destination.

For accomplishing this type of transaction, the seller must know the various import costs along with the customs formalities needed for the hassle-free passage of the product at the destination port. The presence of different import systems necessitates local presence to get this type of transaction successfully fulfilled.

For DDP, the buyer enjoys the least amount of risk in the arrangement.

DPU (Delivered at Place Unloaded 'named place of destination')

DPU is similar to DAP with the exception that the goods are unloaded at the named destination and the seller may be responsible to bear any costs with delays or demurrage charges at the destination terminal.

Real-world implementation of Incoterms

1 - FOB Shenzhen

In Shenzhen, the seller has the responsibility to bring the product to the port. They also need to arrange for all the documents required for its export to another country. The seller is required to handle the customs declaration officials and process at Shenzhen. Once the seller completes all formalities, the product responsibility passes to the buyer. At this point the buyer has to book the shipping from Shenzhen. The buyer also takes care of all the costs after the vessel moves off from Shenzhen to the destination. These may include factors like VAT and port charges.

2 – EXW Yiwu

Under this arrangement, the seller's responsibility is limited to making the consignment available for transportation from his warehouse or factory. The contract will specify if the seller or buyer will bear the loading and transportation from the source.

Once the workers load the product on the truck, the responsibility passes from the seller to the buyer. The buyer is responsible for arranging the export paperwork and export duties. Since the buyer might not be familiar with China's policies and protocols on exports, it will help to have a local presence (agent) to sort out issues like documentation and the various export formalities

3 – DDP LA

Under this arrangement, the seller's responsibility stretches until the end of the logistics process. So, first, the seller will need to take care of a few formalities in their home country. The seller is responsible for the packing of the goods, transporting it to the port, getting all paperwork done to obtain customs clearance, and loading it on the vessel.

Next, the seller will need to consider all protocols and paperwork required for the destination country. Once the consignment reaches the destination port, the seller will need to pay for any import customs declarations and keep all papers ready to release the product from destination country customs to the buyer office or warehouse.

Challenges can arise for the seller if they are not well versed with the destination country's import formalities or protocols. It is important to have detailed knowledge of all steps and processes to be followed for the safe and successful release of the product at the destination country's customs clearance zone. The risk is exceptionally high for the seller. In case where the product gets stuck in the other nation, he has to incur losses for every day the product shipment is delayed. It also erodes the seller's credibility for on-time delivery.

Common mistakes in applying and understanding Incoterms

1 – Seller applies DDP without details of import protocols

Only a handful of sellers would know the import formalities in the countries they export the product to. If they aren’t aware of the import regulations in the buyer’s nation, then it doesn’t make sense to go with the DDP approach. It may happen that the system in the destination country would be complex and lead to potential loss to the exporter.

2 – Misunderstanding ownership and risk

Both buyers and sellers involved in international trade need to understand the difference between risk and ownership. This is especially true when they involve incoterms. In this set of rules, the ownership doesn’t pass from the seller to intermediaries to buyer. These rules apply only to the risks and delegates the right attribution out of the various touchpoints involved in international trade.

3 – Not using the right incoterms

The seller must take care to use the right incoterms. This choice depends on the type of shipping they opt for. For example, if the seller is going for an ocean vessel, then they need to understand that their responsibility doesn’t end with the product being loaded in the truck outside their warehouse. The seller will need to arrange for a carrier and transportation from warehouse to home country port. The seller will also need to safeguard the consignment in case the vessel isn’t leaving the port immediately (which is often the case). The seller continues this risk exposure until the time the product is loaded on the vessel on the date of the journey.

4 – Using EXW always

The buyer is at a distinct disadvantage with Ex Works (EXW). The buyer needs to be fluent with the customs formalities in the country of origin and handle all export formalities too. This uncertainty of export license at the seller end makes the buyer pay more for this aspect. If you travel overseas as a buyer to source goods from multiple traders or sellers, then beware before agreeing to EXW shipping.

5 – Using the incorrect address

When using incoterms, it is essential to use the right delivery address. Doing this step will help curtail additional expenses and keep shipping costs to the minimum.

6 – The dangers of demurrage

If the laytime of the product is more than expected, then it incurs steep charges. This amount can derail the profitability of the transaction and expose the seller/ buyer to risks. This point is especially applicable to the C and D terms.

Incoterms based on the mode of transport

multimodal transport

Conclusion

There are many touchpoints involved in shipping a product form a country of origin to the destination country. Every party must know the extent and limits of his rights and responsibilities. So that all terms of the contract can be met without any issue from the concerned parties. This streamlined facilitation of import-export of products is what makes Incoterms such a valuable concept to master.

These set of rules can remove or reduce uncertainties and chances of misuse to a great extent. Additionally, both parties will clearly know what role they are playing at each phase of the delivery from Point A to Point B. This way, knowledge of incoterms can reduce overall costs of shipping and customs, and ensure successful transactions.

EXW

FCW

CPT

DPU

DAP

DDP

Exclusions to Note

These incoterms do not cover certain terms. They will not put any rule on payment for the consignment. These terms do not include the insurance process. Even for passage of ownership, this set of protocols does not have any specific provisions.

FAS

FOB

CFT

CIF

sea and inland waterway transport