What Are Incoterms? Incoterm Definition And Meaning In Shipping

As an international buyer or seller, there are common terms, called incoterm used in international trade that you should know to protect your interests. Not understanding the incoterm in shipping can lead to delays and disputes that can affect your business.

The trade terms outline the responsibilities of international businesses doing business together for the carriage of goods from the buyer to the seller, and export and import clearance. By mentioning the risks and costs for each party involved in fulfilling a trade, there are no disputes and international trade is facilitated seamlessly.

Incoterms aka International Commercial Terms are considered the common commercial trade terms in the world. However, there are a few countries that have their own trade rules for international trades by making small amendments to Incoterms.

The idea behind having common commercial trade terms is to hold both parties accountable for their roles in international trade. Hence, understanding common terms for international trade will protect you from trade risks by allowing you to negotiate the right trade terms for your shipments.

Benefits of Using Common Terms in International Trade

The use of the world’s essential terms of shipping, that allows buyers and sellers around the world to connect with each other, independent of risks and other barriers to trade. Not many understand and use Incoterms properly. However, when you take advantage of using the right shipping terms, there are fewer disputes and delays in the supply chain process.

Incoterms Empower International Trade

International trade gets a boost with the proper usage of Incoterms. Buyers and sellers can simplify the process by using the correct shipping terms to minimize disruptions.

When there are no disruptions to the process, there is a steady flow of goods and money in economies leading to more growth and productivity.

The incoterm represents a universal term that defines a transaction between importer and exporter so that both parties understand the tasks, costs, risks, and responsibilities, as well as the logistics and transportation management from the exit of the product to the buyer’s country by the importing country.

Incoterms are all the possible ways of distributing responsibilities and obligations between two parties. It is important for the buyer and seller to pre-define the responsibilities and obligations for the transport of the goods and include these in the sales contract, including with the payment negotiated.

Financial Advantage

Incoterms allow buyers and sellers who know the terms they need to use to protect their shipments while saving money. When you know the common terms, you may request for changes for favorable terms in trades. As the more beneficial party in a trade, you can focus on offering the savings as discounts for your customers and grow your business.

Prevents Trade Barriers

International trade has barriers including a language barrier that can lead to a break in communication between buyers and sellers.

When common shipping terms are used, buyers and sellers can minimize mistakes in completing trades. Each party will clearly understand the roles and responsibilities so that penalties and criminal activities are avoided.

Incoterms Clarify Responsibilities of Parties to a Sales Transaction.

In each Incoterm rule, a statement is provided as to seller’s responsibility to provide the goods and commercial invoice in conformity with the contract of sale.

Trade Agreements

Every country implements policies and procedures, which shippers must stay up-to-date with to clear customs and avoid fines and delays.

The International Chamber of Commerce (ICC) established a set of global terms to help facilitate trade agreements and ensure smooth international trade contracts.

These terms help verify the obligations and responsibilities of buyers and sellers during international trade.

The ICC introduced them to minimize misunderstandings and errors in domestic and international negotiations.

Customs Formalities

Each Incoterm rule has a statement stipulating which party is responsible for obtaining any export license or other official authorization required for export and for carrying out the customs formalities necessary for the export to proceed.

Similarly, each rule has a corresponding statement as to which party is responsible for obtaining any import license or other official authorization required for import and for carrying out the customs formalities required for the import of goods.

Incoterms Rules

The Incoterms ® rules define certain key responsibilities for buyers and sellers for the delivery of goods under B2B sale contracts, including passage of risk from seller to buyer, export and import clearances, responsibility for arranging transport, and allocation of costs. Incoterms are helpful terms used to facilitate international trade.

Note that while the Incoterms ® rules specify when risk for the goods passes from seller to buyer, they do not indicate when legal ownership of/title to the goods moves to the buyer. When an Incoterms ® rule is included in a contract of sale, it creates legal obligations for the buyer and seller, which can have costly implications.

Sea and Inland Waterway Transport

Seven of the rules – EXW , FCA , CPT , CIP , DAP , DPU , and DDP – may be used with any kind of transport, or a combination of different modes of transport, including inland waterway transport.

The remaining 4 rules – FAS , FOB , CFR , and CIF – may be used only for sea and inland waterway transport.

Below, we will discuss Incoterms used for all modes of transport, as well as of those used only for sea and inland waterway transport.

Most Common International Commercial Terms

It is important to note that shipping terms are grouped together depending on the responsibilities of the buyer and seller. Incoterms beginning with the letter F refers to primary shipping costs not paid by the seller. Terms beginning with the letter C refers to shipments paid by the seller.

Terms beginning with the letter E refers to the seller’s responsibilities fulfilled when the goods are ready to leave the facility. Terms beginning with the letter D refers to seller’s responsibilities fulfilled when shipments reach a specific point.

Incoterm EX-Works (EXW)

An advantageous trade term for the seller, Ex-Works Incoterm imposes only minimum obligations on the seller.. The buyer has the most responsibility in the fulfillment of the trade. In an Ex-Works transaction, the seller makes the goods available for pickup at the seller’s facility.

The goods are considered “delivered” when they are released to the buyer’s freight forwarder. The buyer has to take care of export and import customs clearance process, shipping insurance, and all other paperwork.

Under EXW, the buyer must also bear responsibility for possible risks such as loading and transferring the shipment and passing customs regulations.

The buyer assumes responsibility for picking up these goods and transporting the cargo from origin to the port of destination.

The buyer also takes on the shipping costs and risk of loss until the inventory reaches the designated location.

EXW Summarized: The seller makes the goods available at its location, so the buyer can take over all the transportation costs and also bears the risks of bringing the goods to their final destination.

Incoterm Free On Board (FOB)

FOB specifically refers to ocean shipments or shipments through the inland waterways. The seller uses a freight forwarder to move the goods to the designed port of the buyer. Goods are considered “delivered” when goods are released to the buyer’s forwarder. When the goods are released, the responsibility for insurance and transportation is transferred to the buyer.

The buyer pays cost of marine freight transportation, bill of lading fees, insurance, unloading and transportation cost from the arrival port to destination.

Incoterm Free Carrier (FCA)

The seller is responsible for arranging the transportation and is responsible for the entire shipment until it reaches an agreed location or destination port, such as an ocean dock, air cargo terminal, warehouse, or another specified facility.

Seller delivers the goods to the carrier or another person nominated by the buyer. In FOB, the buyer chooses the freight forwarder of his choice.

However, in FCA (Free Carrier), the seller chooses the freight forwarder to move the goods to the buyer. After the buyer takes over all the costs, including the freight costs. the risk passes when the goods are handed over to the first carrier.

The goods are considered “delivered” when they arrive at the agreed location. The buyer is responsible for the insurance.

FCA Summarized: FCA is the initials used for “Free Carrier,” or the seller’s obligation to deliver the goods to the carrier requested by the buyer at the seller’s premises or another named place.

Incoterm Free Alongside Ship (FAS)

The buyer is at a maximum disadvantage here as he accepts all transportation costs and the risk of loss of goods. The seller clears the goods for export. The goods are considered “delivered” when they’re handed over to the buyer’s forwarder for transportation and insurance costs.

The seller delivers the goods when it either places them alongside the ship/vessel nominated by the buyer at the named port of shipment or it procures the goods so delivered. The risk/damage to the goods passes from the seller to the buyer when the goods are alongside the ship. The seller handles export clearance formalities, while the buyer must pay unloading and ocean freight costs and cargo insurance.

Incoterm Cost and Freight (CFR)

Formerly known as CNF, it defines the responsibilities for the cost of the goods (‘C’) and freight charges (‘F’). The seller is responsible for moving the goods to the agreed-upon location. The buyer is responsible for getting insurance to cover the goods from the point of shipment to the buyer’s doorstep. The seller is responsible for the transportation and the forwarder.

Incoterm Cost, Insurance, and Freight (CIF)

CIF is similar to CFR and differs only by the fact that instead of the buyer insuring goods for moving to the destination port, it will be the seller who insures the goods.

The goods are considered “delivered” when they reach the agreed-upon location. The seller delivers the goods on board a designated vessel named by the buyer.

The principal difference between CIF (Cost, Insurance and Freight) and CFR (Cost and Freight) resides in the requirement under the CIF Incoterm for the seller to conclude insurance covering against the buyer’s risk of loss of/damage to the goods from the port of shipment to, at least, the port of destination.

Incoterm Carriage Paid To (CPT)

CPT is similar to CIF and differs only by the fact that the seller has to buy insurance to name the buyer as the insured while the goods move to the agreed-upon location. Seller delivers the goods to the carrier or another person nominated by the buyer.

Incoterm Carriage and Insurance Paid To (CIP)

CIP relies on the carrier’s insurance. The seller buys a minimum insurance coverage. Freight forwarders usually act as carriers. The buyer’s insurance becomes active when the goods are delivered to the forwarder and the forwarder will send shipment to the agreed-upon location. Insurance paid by seller.

Same as “Carriage Paid To” but the seller also contracts for insurance cover against the buyer’s risk of loss of or damage to the goods during the carriage.

Incoterm Delivered At Place (DAP)

The seller delivers when the goods are placed at the disposal of the buyer before being unloaded at the named place of destination.

The seller bears all risks involved in bringing the goods to the named place.

They must pay full shipping costs, export formalities, loading expenses, and the final delivery fee. They are also responsible for damages or losses while the goods are in transit.

The buyer covers the cost of unloading, local taxes, and import taxes when the inventory arrives at the agreed-upon location.

Contrary to the CPT/CIP Incoterms, the place of delivery and the place of destination are the same under the DAP Incoterm. Therefore, the seller bears the risk until it has put the goods at the disposal of the buyer at the place of destination.

Incoterm Delivered at Frontier (DAF)

The seller hires a forwarder to move the goods to a border crossing point for export. The goods are considered “delivered” when they are moved to the determined frontier. The buyer is responsible for picking up goods after export clearance and clear them for import. Usually, the buyer’s forwarder handles the task of clearance.

Incoterm Delivered Ex Ship (DES)

The seller is responsible to move the goods to the destination port or engage with the forwarder to move to the destination port. The goods are considered “delivered” then. Destination changes when the ship is docked becomes the buyer’s responsibility.

Incoterm Delivered Ex Quay (DEQ)

The buyer is responsible for customs duties, clearance, and other charges. Meanwhile, the seller is responsible for delivering the goods to the destination port or quay.

Incoterm Delivered Duty Paid (DAT)

Delivered at Terminal. This term means that the seller delivers the goods to the buyer to the named terminal not the place of destination) in the contract of sale, unloaded from the main carriage vehicle.

The seller is responsible for making a safe delivery of goods to the named terminal, paying all transportation and export and transit customs clearance expenses.

Under DAT, the seller is held accountable for the carriage paid and the delivery of goods. The liability transfers to the buyer once the items are unloaded. The buyer covers import duties and local taxes and manages import clearance formalities.

DAT is the only Incoterm that makes the seller responsible for unloading the inventory at the port of arrival.

Incoterm Delivered At Place Unloaded (DPU)

The seller bears all risk involved in bringing the goods to the place of destination and unloading them there. The risk is transferred to the buyer when this has been done and customs clearance has been completed.

DPU Incoterm replaces the old DAT, with additional requirements for the seller to unload the goods from the arriving means of transport.

Incoterm Delivered Duty Paid (DDP)

The seller is responsible for all the tasks from manufacturing the goods to shipping them from the seller’s warehouse to the buyer’s doorstep.

Customs duties, insurance, transportation costs, and other charges are taken care of by the seller.

These risks include export and import duties, insurance, and extra costs that may occur during the time in transit to an agreed location. If a shipment is delayed or damaged, the seller is held accountable. (DDP) delivered duty paid means delivered duty paid by the seller.

Incoterm Delivered Duty Unpaid (DDU)

DDU is similar to DDP and differs only by the fact that the buyer is responsible for customs charges, fees, and taxes.

It can be confusing for many to understand the various terms in international trade. However, considering the huge benefits that come with it including huge savings, it pays to give more attention to the trade terms before agreeing on an international trade deal.

Internation Trade Administration

Any time you are unsure about something regarding international commercial terms or international transport, you can always reach out to the International Trade Administration. Go to their website thru this link: International Trade Administration.

Sales Contracts

As of January 1, 2020, all sales contracts should include references to the Incoterms® 2020 rules. You may obtain Incoterms® 2020 detailed rules and international trade terms visit the ICC website.

Final Thoughts

Always make sure you agree on the the contract terms and put it in a contract. Make sure you put in the contract the shipment is delivered at place unloaded or some other arrangement that was agreed by both sides.

Often buyer assumes certain things and it doesn’t work they way they thought. That is why putting everything in the contract is essential.

This is important even when the buyer has purchased from the same vendor before. It is important that the insurance cover the shipment from leaving the warehouse to the port of destination or even all the way to the buyer’s final location.

Make sure you are familiar with the Incoterms you are using for your shipment. Also, make sure that you understand the cost and freight of the shipment from seller to the buyer completely. There can be misunderstandings on both sides. Using incoterms and contracts will help avoid these misunderstandings.