When shipping products for the first time you will come across “Incoterms.”
But what are Incoterms, and how do they affect you?
In this article, we’ll explain everything you need to know about Incoterms including what each term means and when they are typically used.
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What are Incoterms?
Incoterms are international commercial terms that can be seen in international sales contracts defining the responsibilities of buyers and sellers when it comes to the shipment process or the transportation and delivery of goods.
They are published by the International Chamber of Commerce (ICC) and are used by businesses around the world and are recognized by different countries to help facilitate international trade to determine which party is responsible for certain costs and risks involved in the transportation of goods.
There are 11 incoterms in total, each with unique terms and stages of the transfer of responsibility from seller to buyer. Here’s a helpful diagram we made for you to reference:
Incoterms are divided into two main categories – those used for any mode of transport, and those used for sea and inland waterways.
Incoterms rules used for any mode of transport
Ex Works (EXW)
EXW term places a minimum obligation on the seller as their responsibility ends once the goods are ready for pick up within their premises. This can include the seller’s factory, warehouse, or other location.
If you are buying the goods on EXW terms, you’ll have to collect the goods from the seller’s premises.
So other than providing access to the shipment, you cannot expect the seller to be involved in the loading of cargo unless an agreement has been made beforehand.
However, even if the seller has agreed to assist with the loading of the shipment on EXW transaction, the buyer would still be held liable for any damages incurred during this period.
Furthermore, the buyer is responsible for taking care of any documentation required and covering the costs needed to get the goods to the place of destination.
It is recommended to have a freight forwarder to help with this process, as they are more familiar with the documentation and requirements needed for exporting goods.
Free Carrier (FCA)
The seller is responsible for delivering the items to the carrier nominated by the buyer.
Depending on the agreed delivery location, the seller’s responsibility may include arranging all pre-export documentation required, completing export clearance processes, as well as taking care of loading formalities.
The seller’s obligation ends once the goods have been delivered.
If you are buying goods on Free Carrier terms, you’ll assume all risks involved and costs in moving the goods from that point on going to the place of destination.
Carriage Paid To (CPT)
The seller is responsible for arranging the carriage contract and covering the transportation cost of the goods to the agreed place of destination, which is commonly overseas.
If you are buying the goods on Carriage Paid To terms, you’ll be responsible for the goods and will assume all risks involved at the agreed place of destination.
However, since insurance isn’t part of what the seller is required to provide, you’ll have to take care of the full cargo insurance from the point of origin to the destination.
Additionally, you’ll need to prepare shipping documentation like import permits and customs clearance, as well as pay any applicable duties and taxes.
It is recommended for the buyer to ensure that payment has already been completed for the goods before the delivery is made by the seller.
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Carriage and Insurance Paid To (CIP)
Similar to Carriage Paid To term, the seller delivers the goods to the agreed place of destination on the seller’s account.
However, under this term, the seller is also responsible for arranging and paying for cargo insurance. The minimum insurance coverage under the Institute Cargo Clauses is Clause C which is usually what the sellers provide.
If you prefer additional insurance coverage beyond this, you may discuss it with the seller and have the payment negotiated.
Since the CIP term may be used for any mode of transport, this can include movement via road, rail, and sea.
This means that if you are buying the goods on Carriage and Insurance Paid To terms, you’ll be responsible for the goods and will incur all risks involved once the seller hands over the cargo to the first carrier or when it has arrived at the agreed place of destination.
Delivered At Place (DAP)
The seller delivers the goods to the place of destination specified by the buyer. This location could be within the buyer’s premises, or any place that has been agreed upon mutually.
Additionally, the seller will be responsible for ensuring that the goods get shipped to the agreed location without damage, covering the transportation costs up to the agreed place, doing export clearance formalities, as well as preparing carriage contracts and export permits.
If you are buying on DAP terms, you’ll be responsible for the goods once you’ve received them at the agreed location and you will incur all risks and costs such as the insurance after the point of delivery.
In addition, you’ll also need to take care of the import documentation, as well as import customs formalities.
Delivered at Place Unloaded (DPU)
Also known as DAT (Delivered at Terminal) in Incoterms 2010.
The seller is responsible for arranging the carriage and unloading the goods to the place of destination. This can be a port, terminal, warehouse, or another facility.
However, unlike Delivered at Place terms, this rule places additional responsibility on the seller in unloading the goods at the agreed location.
If you are buying the goods on DPU terms, you’ll be responsible for the goods only when they have been unloaded by the seller at the agreed place of destination.
This means that as the buyer, you will incur all risks after the goods have been unloaded and you will need to shoulder all the costs involved in getting the goods to your final destination.
Delivered Duty Paid (DDP)
This is the only incoterm rule that gives a maximum obligation to the seller.
Under DDP conditions, the seller delivers the goods to the buyer’s door or within the buyer’s premises.
Moreover, the seller bears the responsibility for the customs clearance process, as well as, the responsibility of paying all duties and taxes.
Since the seller bears additional risk, this incoterm is the most expensive incoterm option for the buyer.
Note that under this condition, neither the seller nor the buyer is required to cover the insurance of goods.
Incoterms rules used for sea and inland waterway
Free Alongside Ship (FAS)
The seller is responsible for delivering the goods to the dock or quay alongside the vessel nominated by the buyer.
As part of the delivery of goods to the destination port, the seller is also responsible for arranging the carriage with various carriers going to the nominated port or vessel.
Additionally, the seller is also in charge of preparing any shipping documents like export permits and quotas relating to the cargo.
Under FAS terms, insurance for the goods is not required from either the buyer or the seller.
Since cargo has to be placed alongside the ship on FAS terms, this incoterm is more applicable for non-containerized cargo. Cargos that are containerized, on the other hand, are recommended to be delivered at a container terminal.
From that point on, the risk passes from seller to buyer.
Free On Board (FOB)
Similar to FAS terms, the seller is responsible for delivering the goods to the destination port. However, there’s an added responsibility on the seller to load the goods onto the vessel nominated by the buyer.
As part of the delivery, the seller also shoulders the transportation costs and is responsible for any documentation that may be required in handling export formalities for the shipment.
If you are buying on FOB conditions, you’ll be responsible for nominating the correct type of vessel, as well as, arranging the contract of carriage.
In addition to that, you’ll incur risks and costs involved in the cargo once the goods have been loaded on board the vessel.
Under FOB terms, neither the seller nor the buyer is responsible for securing insurance for the goods.
Cost and Freight (CFR)
The seller is responsible for handling the delivery process going to the specified destination. Since this setup is exclusively used for sea and inland waterway, the destination should be accessible through waterways.
Part of the seller’s responsibility is to handle export clearance formalities, pay for the freight costs as well as the loading and unloading costs of the shipments, and arrange any required cargo documents.
The seller is also required to hand over the bill of lading to the buyer to serve as proof of delivery and termination of risk.
Once the seller has fulfilled the obligation, the buyer assumes the risk and handles the next steps.
This includes carrying the risk from that point on, arranging and paying the transport going to the final destination, preparing import permits and quotas, and taking care of import customs clearance.
Cost, Insurance, and Freight (CIF)
The seller covers the transportation of the cargo to a destination that must be accessible through waterways like a seaport.
In delivering the shipment to the destination port, the seller is expected to take care of export formalities, arrange documents relating to the cargo, and cover the costs of loading and unloading the goods.
Although the same obligations apply with CFR, in this transaction, the seller is also responsible for obtaining the cargo insurance and paying for the insurance costs.
The minimum insurance coverage for the cargo should be equal to the commercial value of the goods as stated in the sales contract plus 10% to cover the average profit the buyer makes for the goods.
Furthermore, even if the risk has transferred to the buyer once the cargo has onboarded the ship, the insurance to be obtained by the seller must cover the entire duration of the shipment of goods until it reaches the port of destination.
Shipments under CIF transactions can either be containerized or non-containerized so the seller just needs to make sure to select the right carrier for the carriage.
As you can see, there are a lot of different incoterms, and each one has its own set of responsibilities for buyers and sellers.
It’s of utmost importance to understand these international trade terms.
Using Incoterms on sales contracts worldwide helps ensure that everyone involved in the shipment process understands their responsibilities and when the risk passes on to them to avoid any misunderstandings.
Advantages and Disadvantages of using Incoterms
Advantages of Using Incoterms
Some of the benefits of using incoterms include:
- They help to avoid misunderstandings between buyers and sellers.
- They help to ensure that everyone involved in the shipment process knows their responsibilities.
- They can help to save time and money by clearly defining who is responsible for what.
Disadvantages of Using Incoterms
Some of the disadvantages of using incoterms include:
- They can be complex and difficult to understand.
- They can be expensive to use.
- They may not cover all potential risks and costs.
Using these international trade terms can be challenging, but they can be very beneficial in ensuring that everyone involved in the shipment process knows their responsibilities.
We recommend using incoterms that protect both parties to ensure that buyer’s risk is mitigated and the seller’s obligations are clear.
When in doubt, always consult with an expert to ensure that you are using the best incoterms for your particular shipment.
Frequently Asked Questions
What has changed in Incoterms 2020 rules from Incoterms 2010?
There are four main changes in Incoterms 2020:
- The removal of incoterms that were specific to particular modes of transport (e.g. DAF, DES, DEQ, and DDU)
- The addition of two new incoterms: DPU (Delivered at Place Unloaded) and FCA (Free Carrier)
- The redefinition of the incoterms CPT and CIP: In Incoterms 2010, CPT and CIP required the seller to insure the goods, while in Incoterms 2020, this is no longer the case.
- The clarification of the rules for incoterms DAT and DAP
Can I still use Incoterms 2010 now that Incoterms 2020 is available?
Yes, you can still use Incoterms 2010 for international trade.
However, the International Chamber of Commerce (ICC) recommends using the latest version, Incoterms 2020, as it is more up-to-date and reflects the current state of international trade.
Why should I use Incoterms to facilitate trade practices?
Incoterms are important because they determine who is responsible for what costs and risks are associated with the shipment of goods.
This also helps eliminate inconsistencies and misunderstandings that can often occur during international trade.
What is the difference between incoterms and terms of sale?
Incoterms are international trade terms that specify the responsibilities of buyers and sellers for the shipment of goods.
Terms of sale, on the other hand, are more general and cover a wider range of topics, such as payment terms, prices, discounts, etc.
Is it required to use Incoterms when doing international trade?
No, Incoterms are not required by law.
However, they are highly recommended as they can help to avoid misunderstandings and disputes between buyers and sellers.
Are the use of Incoterms legally binding?
Incoterms are not legally binding on their own as they only serve as guidelines to facilitate international trade.
However, they can become legally binding once they are included in a contract of sale.
Who should use Incoterms?
Incoterms are used by businesses, lawyers, and courts around the world to determine which party is responsible for what costs and risks during the shipment process.
What is the difference between Freight Collect and Freight Prepaid?
Freight Collect means that the buyer or the importer is responsible for paying the freight charges. Incoterms that use Freight Collect include EXW, FAS, FCA, and FOB.
On the other hand, Freight Prepaid means that the seller is responsible for paying the freight charges. This means that if you sell or export goods on CIF, CIP, CFR, CPT, DAP, DPU, or DDP terms, you’ll need to pay for the freight charges.
Definition of Basic Terms
Bill of Lading – A document that lists the goods being shipped, the origin and destination of the shipment, and other important information.
Cargo – The goods that are carried on a vessel, airplane, or truck.
Carriage – The transportation of goods.
Carrier – The company or person who is responsible for the transport of goods.
Customs – A government department responsible for collecting duties and taxes on imported goods.
Customs Clearance – The process of getting goods through customs.
Duties – Taxes that are levied on imported goods.
Export – The act of sending goods to another country.
Export Formalities – The paperwork and other requirements that must be met in order to export goods.
Freight – Goods transported in bulk
Freight Forwarder – A company that specializes in the transport of goods and often provides other services such as customs clearance and storage.
Import – The act of receiving goods from another country.
Import Formalities – The paperwork and other requirements that must be met in order to import goods.
Inland Waterway Transport – Transportation of goods by barge or other vessels on a river, canal, or lake.
Port of Shipment – The port where the seller loads the goods onto the vessel.
Quotas – A limitation on the number of goods that can be imported or exported.
Sales Contract – The contract between the buyer and seller that contains the details of the sale, including the incoterms.
Seller’s Premises – The place where the seller has their business. This is usually the factory or warehouse where the goods are produced or stored.
Vessel – A ship, boat, or other craft used for carrying people or goods on water.
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