Complete Guide to Understanding Incoterms

Every industry tends to have its own unique terminology and the logistics sector is no different. If clients and new prospective clients can understand the terminology used, then it can help facilitate more efficient communications at all stages of the provider-client relationship, save time, and lead to smoother processes. In logistics, one of the most common sets of these is Incoterms and the associated terms that go along with it. 

What are Incoterms

Incoterms is an abbreviation of the phrase International Commercial Terms. It is a term trademarked by the International Chamber of Commerce. Their purpose is to aid communication and reduce confusion when dealing with international and global trade. An Incoterm is something that describes and defines a transaction between two parties, usually the party exporting goods and the party importing them. These terms set out the various parts of trade and can assign which party is responsible for the various costs, tasks, and processes. They also cover all parts of the import-export and transportation process, from the goods leaving the point of production to them being accepted at the importing port. They cover all the ways in which the different parties share obligations and responsibilities. The International Chamber of Commerce has published new Incoterms 2020 rules that have come into effect from the 1st of January 2020. Incoterms play such a vital role in the world of global trade. While Incoterms 2020 may seem complicated, it’s imperative that buyers and sellers clearly understand how they work and their own obligations along the supply chain.

What Areas do Incoterms Cover?

There are four main areas of responsibility that Incoterms cover:

  • Delivery stage: This is where the seller and buyer make an agreement for the details of the cargo’s final delivery, and when the goods exchange hands and the seller’s responsibility ends.
  • Transportation stage: Incoterms set out which party is responsible for transportation costs, how these costs are shared, or whether each party takes responsibility for different stages of transportation.
  • Documentation and formalities: Incoterms set out which parties take responsibility for dealing with all customs, export, and import documentation, formalities, and duty payments.
  • Insurance: Incoterms set out which party is responsible for providing insurance coverage during transportation.

Incoterms Definitions

EXW - Ex-Works

One of the simplest and most basic shipment arrangements places the minimum responsibility on the seller with greater responsibility on the buyer. In an EX-Works transaction, goods are basically made available for pickup at the shipper/seller’s factory or fulfillment center and delivery is accomplished when the merchandise is released to the consignee’s 3PL (third-party logistics provider). The buyer is responsible for making arrangements with their freight forwarder for insurance, exports clearance.

FAS - Free Alongside Ship

In these transactions, the buyer bears all the transportation costs and the risk of loss of goods. FAS requires the shipper/seller to clear goods for export, which is a reversal from past practices. Companies selling on these terms will ordinarily use their 3PL to clear the goods for export. 

FCA - Free Carrier

In this type of transaction, the seller is responsible for arranging transportation, but he is acting at the risk and the expense of the buyer. Where in FOB the 3PL or carrier is the choice of the buyer, in FCA the seller chooses and works with the 3PL or the carrier. Under this term, the buyer can instruct its carrier to issue a bill of lading with an on-board notation to the seller so that they may satisfy the terms of a letter of credit. 

FOB - Free On Board

One of the most commonly used and misused terms, FOB means that the shipper/seller uses their 3PL to move the merchandise to the port or designated point of origin. Though frequently used to describe inland movement of cargo, FOB specifically refers to ocean or inland waterway transportation of goods. Delivery is accomplished  when the shipper/seller releases the goods to the buyers’ forwarder. The buyer’s responsibility for insurance and transportation begins at the same moment.

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CFR - Cost and Freight

The seller pays for the carriage of the goods up to the named port of destination. Risk transfers to buyers when the goods have been loaded on board the ship in the country of Export. The Shipper is responsible for origin costs including export clearance and freight costs for carriage to named ports. The shipper is not responsible for delivery to the final destination from the port (generally the buyer’s facilities), or for buying insurance. If the buyer requires the seller to obtain insurance, the Incoterm CIF should be considered. CFR should only be used for non-containerized sea freight and inland waterway transport; for all other modes of transport it should be replaced with CPT.

CIF - Cost, Insurance and Freight

This arrangement is similar to CFR, but instead of the buyer insuring the goods for the maritime phase of the voyage, the shipper/seller will insure the merchandise. In this arrangement, the seller usually chooses the forwarder. 

CPT - Carriage Paid To

In CPT transactions the shipper/seller has the same obligations found with CIF, with the addition that the seller has to buy cargo insurance, naming the buyer as the insured while the goods are in transit.

CIP - Carriage and Insurance Paid To

This term is primarily used for multimodal transport. Because it relies on the carrier’s insurance, the shipper/seller is only required to purchase minimum coverage. When this particular agreement is in force, 3PLs often act in effect, as carriers. The buyer’s insurance is effective when the goods are turned over to the forwarder.

DPU - Delivered At Place Unloaded

This Incoterm requires that the seller delivers the goods, unloaded, at the named place of destination. The seller covers all the costs of transport (export fees, carriage, unloading from main carrier at destination port and destination port charges) and assumes all risk until arrival at the destination port or terminal. The terminal can be a port, airport, or inland freight interchange, but must be a facility with the capability to receive the shipment. If the seller is not able to organize unloading, they should consider shipping under DAP terms instead. All charges after unloading (for example, Import duty, taxes, customs and on-carriage) are to be borne by a buyer. However, it is important to note that any delay or demurrage charges at the terminal will generally be for the seller’s account.

DAP - Delivered At Place

The seller delivers when the goods are placed at the disposal of the buyer on the arriving means of transport ready for unloading at the named place of destination. Under DAP terms, the risk passes from seller to buyer from the point of destination mentioned in the sales contract of delivery. Once goods are ready for shipment, the necessary packing is carried out by the seller at his own cost, so that the goods reach their final destination safely. All necessary legal formalities in the exporting country are completed by the seller at his own cost and risk to clear the goods for export. After arrival of the goods in the country of destination, the customs clearance in the importing country needs to be completed by the buyer, e.g. import permit, documents required by customs and etc., including all customs duties and taxes. Under DAP terms, all carriage expenses with any terminal expenses are paid by the seller up to the agreed destination point. The necessary unloading cost at final destination has to be borne by the buyer under DAP terms.

DDP - Delivered Duty Paid

DDP terms tend to be used in intermodal or courier-type shipments. Whereby the shipper/seller is responsible for dealing with all the tasks involved in moving goods from the manufacturing plant to the buyer/consignee’s door. It is the shipper/seller’s responsibility to insure the goods and absorb all costs and risks including the payment of the duty and fees.

Incoterms Shipping Terms Glossary

Below are some of the most common words and phrases that appear in the Incoterms rules.

3PL (Third-Party Logistics Provider)

A company providing a range of transportation services for cargo shipments.

Break Bulk Cargo

Conventional, un-containerized cargo that ships in units of one or packages, such as vehicles, machinery, palletized or boxed cargo.

Bulk Cargo

Cargo that is composed either of 1) free flowing articles, like oil, grain, ore or coal or 2) uniform cargo that stows solid, such as coils, pipes, sheets of metal, timber and lumber.

Bonded Warehouse/Terminal

A warehouse or terminal approved by the U.S. Treasury Department for storing goods until duties are paid or the goods are released.

Carriage

Transportation of cargo while on board the main carrier from airport/port of loading to airport/port of discharge.

Carrier

An individual or legal entity in the business of transporting goods for hire.

Customs-Trade Partnership Against Terrorism (C-TPAT)

A voluntary business initiative, administered by U.S. Customs and Border Protection (CBP), to ensure the integrity of the supply chain among importers, carriers, brokers, warehouse operators and manufacturers.

Customs Broker

An individual or firm licensed by U.S. Customs and Border Protection to handle a sequence of customs formalities required for the import and export of goods.

Delivery

In the Incoterms rules, delivery refers to the point when risk transfers from seller to buyer. This is often, but not always, the same point in the transaction through which the seller has agreed to pay, it is not always the same point. Delivery is thus when the seller has fulfilled their obligation and bears no more risk, even if still responsible for paying for the next stage in the transaction.

Duty

A tax levied by a government on the import, export and consumption of goods. Duties are based on the value of goods as well as factors like weight and quantity.

ICC

The International Chamber of Commerce.

Incoterms / Terms of Sales

Terms that define the obligations, risks and costs of the buyer and seller, involving the delivery of goods that comprise the commercial transaction. Incoterms are organized by modes of transport, either any mode or modes of transport and sea and inland waterway transport terms.

Intermodal

The coordinated transport of long-haul movements using any combination of modes, freight forwarders or motor carriers.

Multimodal (or “any mode”)

The use of more than one mode of transportation to move goods from origin to final destination. The Incoterms for the use of any mode or multiple modes of transportation to move goods from origin to final destination. They are EXW, FCA, CPT, CIP, DAT, DPU and DDP.

On-Carriage

Transportation that takes place after the shipment is offloaded from the main carrier at port of discharge.

Pre-Carriage (inland transportation)

Transportation that takes place prior to the shipment being loaded on board the main carrier at airport/port of loading.

Sea and Inland Waterways 

Specific Incoterms for maritime shipments that cover both inland waterways and seas and where the seller places the goods alongside or on board the vessel at port (and at which point the risk of loss passes to the buyer). They are FAS, FOB, CFR and CIF.

Terminal

An area that serves as a loading, unloading and transfer point for cargo.

Bottom Line

Shipments can face problems without the correct Incoterm so it’s really important to think carefully about which one is appropriate. Failure to understand Incoterm definitions leads to problems throughout the supply chain. For example, logistics costs could increase, the terms may not match the requirements of the buyer or seller or the buyer or seller may not be able to comply with the incoterm. Knowing the definitions of these Incoterms is a helpful way to facilitate international trade. They make the process smoother and quicker for both buyers and sellers.

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