Incoterms: Ultimate Guide to International Commercial Terms
All business deals begin with a seller and end with a buyer. Some transactions of products/goods are local, but many times they are international. When goods move from an international seller to a buyer, the process is more complex: various responsibilities and rules exist.
When a buyer purchases products from an international seller, they must communicate how they want to receive the goods. The logistics factor of international trade is crucial; there needs to be clear communication about who is responsible for which stage.
International commercial terms (incoterms) aim to make the responsibility process easier and more manageable. Both sellers and buyers agree on a specific incoterm for their trade to understand where a seller’s responsibility ends and where a buyer’s begins.
The 11 terms are the ideal risk management strategy for international logistics. A buyer and seller need to understand each incoterm. Hence, this article will explain everything one needs to know about incoterms and the different 11 incoterms.
What are Incoterms?
Incoterms are selling terms developed and implemented by the International Chambers of Commerce (ICC) in 1936. Buyers and sellers worldwide currently use the updated Incoterms® 2020 to help manage costs, risks and responsibilities during international trade.
Incoterms are the internationally recognised selling terms the buyer and seller agree to during international transactions. Buyers and sellers decide on one term per transaction to manage the logistics.
Each term is different to the other and clarifies the agreement of who is responsible for the costs and management of shipment, insurance, documentation, customs clearance, and other logistical activities.
Effective use of Incoterms can avoid conflicts, logistics confusion and promote clear communication.
The 11 Different Types of Incoterms
There are 11 different incoterms, and each intercom distributes the responsibility from seller to buyer at different stages. In addition, please also refer to the incoterms chart created to get a comprehensible understanding of each term.
EXW – EX Works
Ex-works is the incoterm, where the buyer is most responsible for the transaction. The seller is only required to ensure the goods are available for pick up at the agreed location (commonly the seller’s location), and the buyer is responsible for pickup and shipping costs.
The buyer bears most costs, such as loading, shipment, customs and transfer expenses. While bearing most of the costs, they also handle most risks, such as damage, loss or theft of goods before, during or after the journey.
It’s the ideal incoterm when a buyer has purchased products from multiple suppliers and can move numerous goods simultaneously. Also, the easiest term for a seller as they handle minimum risks and costs.
FCA – Free Carrier
Once again, the buyer has the most responsibility when they agree to free carrier FCA incoterm. The seller will deliver the goods to the first carrier or an agreed location in the seller’s country, and from then on, the buyer is responsible for the transportation.
In FCA, the seller is responsible for loading onto the first carrier (truck), unlike EXW. The carrier will move the goods from the designated location to the vessel.
Once again, most risks and costs fall under the buyer. Hence, EXW and FCA should only be agreed upon if the buyer believes they have better costs and extensive knowledge of the country’s trade process.
FAS – Free Alongside Ship
When transporting goods internationally, there is always the use of a transport vessel, typically a ship or plane. FAS incoterm is the agreement the seller will deliver goods alongside the vessel chosen by the buyer. The incoterm can only be in logistics processes with waterway transport.
The responsibility is transferred from the seller to the buyer once the goods are alongside the ship. The seller is responsible for placing the goods safely before or on a specific day and time.
The buyer will endure fewer risks in the international country, but will still be responsible for loading the goods onto the ship.
FOB – Free on Board
With FOB incoterm, the seller responsibly increases one step further. The seller is responsible for loading the goods on board of the ship. Once again, FOB can only be used for waterway transportation.
The buyer is still in charge of the freight costs and onwards. Therefore, the buyers still have control over logistics and shipping costs.
If there is any damage during the loading, the seller will be responsible and have to cover the repair and replacement costs. The buyer does not need to worry about local logistics except for the shipment in the seller’s country.
CFR – Cost and Freight
CFR is an incoterm where the seller takes the most responsibility for moving goods out of the seller’s country. The seller is responsible for organising and paying for freight to the buyer’s specified port. CFR also can only be used for waterway transportation. The buyer takes responsibility as soon as the goods are loaded.
In CFR, the buyer is still liable to buy their own insurance to cover their goods on the ship. The buyer does not have to deal with any risks and costs related to the international country. It is a fair share of responsibility between seller and buyer.
CIF – Cost, Insurance and Freight
CIF is very similar to CFR and is responsible for the same stage. However, in CIF terms, the seller will pay for insurance too. The insurance will cover the cargo during the freight. CIF is the last of the four incoterms that can only be used for waterway transport.
The risk transfers when the seller loads goods onto the vessel. Therefore, if there is any damage during the journey and offloading of goods, the buyer will be liable and have to claim using the seller’s insurance.
CPT – Carriage Paid To
CPT incoterms responsibility leans more toward the seller. The seller is responsible for delivering goods to a designated buyer’s location (second carrier). The seller will have to pay for freight costs but will not pay for insurance. The buyer is responsible for buying insurance.
The risk transfer in this incoterm occurs when the seller has loaded the goods onto the first carrier (seller’s location). After the goods have been delivered to the buyers chosen location – the buyer will be responsible for loading, unloading their carrier and transporting it to the final destination.
CIP – Carriage and Insurance Paid To
CIP incoterm is an agreement that the seller is responsible for delivering the to a designated buyer location or second carrier. Very similar to CPT; however, the seller will pay for the minimum amount of insurance.
The buyer has to handle the unloading of the carrier and pay for any import costs. However, even with insurance, the risk transfer occurs when the seller loads goods into the first carrier. If there is any damage during the transportation, the buyer can claim using the seller’s insurance.
Hence, the seller is not directly responsible for any damage beyond the risk transfer point. It is an ideal incoterm when the buyers do not want to handle most of the responsibility.
DAP – Delivered at Place
DAP incoterm is an agreed term where the seller delivers the goods to the buyer’s location. The seller pays for most costs and bears the most risks. The buyer is still responsible for unloading, further transportation and paying for import fees.
The risk transfer occurs simultaneously with the responsibility transfer at the buyer’s location. The import costs the buyer must pay include custom fees, taxes and tolls.
DPU – Delivered at Place Unloaded
(replaced Incoterm® 2010 – DAT)
DPU is an Incoterm® 2020 that has replaced DAT in Incoterm® 2010. When the DPU term has been agreed upon, the seller is responsible for delivering the goods to the designated buyer location and unloading them.
The buyer is still liable to pay for import costs and possible further transportation costs. The risk transfers to the buyer when the seller unloads the goods at the designated location.
DDP – Delivered Duty Paid
DDP incoterm moves all responsibility onto the seller. The seller is liable to deliver the goods to the final designated destination, unload and pay all costs, including importing fees. The risk transfer occurs when the seller unloads and confirms goods at the final agreed location.
The seller bears all responsibility, costs and risks when the DDP term is on the contract. The buyer can help the seller obtain customs and import clearance documents.
The following explains which incoterm a business can use for different modes of transport.
Term For Any Mode(s) Of Transport: EXW, FCA, CPT, CIP, DAP, DPU & DDP
Terms For Sea and Inland Waterway Transport: FAS, FOB, CFR & CIF
In addition, the most common incoterms are: EXW FOB, CFR/CIF & DDP
Incoterms 2020 Chart
Figure 1: illustrates Incoterms 2020 in a chart form. The chart shows the sellers’, and buyers’ responsibility and the specific risk transfer at the different stages. The responsibility includes costs and expected duty.
Figure 1: Incoterm 2020 Chart
Why Cargo Insurance Is Crucial for Every Incoterms?
Cargo insurance is crucial for sellers or buyers to cover risks and costs associated with international trade logistics. Cargo insurance will protect the value of cargo (goods) from damage, loss or theft due to uncontrollable incidents.
The insurance will cover the goods movement through any transport – ship, flight, truck or train. Insurers can customise the insurance coverage to begin and end in different journey stages.
Even if a seller has purchased a minimum coverage due to the specific incoterm, buyers can purchase their own cargo insurance with a better cover. No matter the incoterm agreed on, the seller or buyer should buy insurance to cover their liability, cargo and finance.
The right cargo insurance policy makes international trade less stressful, as the buyer or seller knows their risks are covered until the specific risk transfers.