Navigate the complexities of international trade with our comprehensive guide to Incoterms 2020. Learn the rules and best practices for smooth transactions.
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Incoterms at a glance!
Say you’re a buyer who has just located a great seller, negotiated a deal, and shook hands. Success!
What happens next? “Are you planning on shipping? Or should I plan it?” And “what happens if the products are damaged in transportation, is that your issue or mine?” These are age-old trading questions that Incoterms answer.
Incoterms (short for “International Commercial Terms”) is a collection of 11 business terms that govern logistics liability in global trade. The International Chamber of Commerce (ICC) defines them and publishes them once per decade (most recently in 2020).
The International Chamber of Commerce (ICC) created the Incoterms in 1936 to eliminate disparities in commercial practices and legal interpretations among traders all over the world. The International Commercial Terms (Incoterms) is a set of standards that define purchasers’ and sellers’ responsibilities for the safe delivery of goods across all forms of transportation.
Simply explained, the Incoterms are the rules that both buyers and sellers must follow when engaging in international or domestic trade. The ICC updates the Incoterms every ten years, and it is always best to refer to the most recent edition.
They outline two major responsibilities:
- Who pays for the logistics? Either the buyer or the vendor.
- Who is responsible for the hazards of transport? As in damage or loss.
What are the three primary functions of Incoterms?
Every international shipment involves several processes, fees, ownership transfers, and dangers for both importers and exporters. Managing these variables is essential to supply chain administration. Without a clear statement of responsibility, a shipment may be delayed, damaged, or lost if it is unclear which party is responsible for contracting transportation or paying insurance, for example. The buyer and seller agree in advance on the Incoterm for a shipment, which aids in determining the three broad goals described below.
It may appear to be a simple process to decide how a shipment will travel from point A to point B. Still, there may be more than one step in an international shipment, and the Incoterm will say exactly how far the seller is responsible for transporting the shipment before the buyer takes over. After that, the buyer is responsible for any additional transportation.
Depending on the route and mode, the cost of international transit might vary significantly. The Incoterm for a shipment not only says who is responsible for transportation but also who is responsible for payment and how that is reflected in the whole transaction. Transportation costs are added to the price of the goods on the invoice and are often deducted when figuring out taxes and duties.
There are multiple points of risk on a long journey. It is crucial to determine which party bears the risk if a package is lost or damaged during transport. The agreed-upon Incoterm will accomplish this, greatly streamlining the resolution procedure.
The terms collectively cover all modes of transportation (road, rail, air, and sea), but some are specific to certain modes. FAS (“Free Alongside Ship”), for example, only applies to sea freight, whereas DDP (“Delivered Duty Paid”) indicates that the seller will deliver the goods with duties paid, regardless of the mode of transportation.
Incoterms are complex at first glance, but once you get the hang of them, they become second nature. Furthermore, in reality, most businesses will utilize a single Incoterm for all commercial agreements to keep things easy.
When a buyer purchases a product internationally, sellers will often include a three-letter abbreviation of one of the 11 Incoterms to specify the terms of the deal. These terms represent various tasks, expenses, risks, and logistics of transporting commodities by sea freight, air freight, and land freight.
Every Incoterm specifies the following obligations and responsibilities:
- Point of delivery – This section specifies where the items will be transferred from the seller to the customer.
- The party liable for transportation charges – This section specifies who will fund the freight costs. This component is frequently referred to as Freight Prepaid or Freight Collect.
- Export and import requirements – Each word specifies whether the seller or buyer is responsible for covering the costs and facilitating the cargo’s export and import.
- Freight insurance responsibility – Freight insurance is required in various Incoterms. Each Incoterm will specify who is responsible for paying for freight insurance.
Incoterms in International Trade
Incoterms play a crucial part in international trade. The Incoterms are a set of rules for the freight business that are not required but are respected.
The significance of Incoterms in international trade
The Incoterms are used by both importers and exporters to make sure that all trade operations go smoothly and that there are no misunderstandings.
- The Incoterms are universally acknowledged and offer businesses predictability.
- They advise sellers and buyers on how to execute transactions and clarify any gray areas in the contract.
- They explain all the changes and help stakeholders figure out how they affect global supply chains.
After going over the different types of Incoterms, we’ll go over the basic parts of Incoterms that are used for all types of transportation, as well as those that are only used for sea and inland waterway transport. Changes to the Incoterms 2020 rules will also be discussed.
There are 11 Incoterms that are recognized by the International Chamber of Commerce (ICC), and they are divided into two categories: those that apply to any mode of transport (E, F, C, D), and those that apply only to sea and inland waterway transport (B, R). Each Incoterm spells out what the buyer and seller are responsible for when it comes to the delivery of the goods, including when the buyer takes ownership of the goods from the seller.
Category E (Departure) has exactly one trade word, EXW (Ex Works).
Category F (Main Carriage Unpaid), includes three trade terms:
- FCA (Free Carrier)
- FAS (Free Alongside Ship)
- FOB (Free on Board)
Category C (Main Carriage Paid), contains four trade terms:
- CPT(Carriage paid to)
- CIP(Carriage and Insurance paid to)
- CFR (Cost and Freight)
- CIF (Cost, Insurance, and Freight)
Category D (Arrival), which contains three trade terms:
- DAP(Delivered at Place)
- DPU (Delivered at Place Unloaded)
- DDP (Delivered Duty Paid)
Each Incoterm contains a set of rules of interpretation for the obligations of both the seller (A1-A10) and the buyer (B1-B10), covering the following issues:
- A1/B1 – General Obligations,
- A2/B2 – Delivery,
- A3/B3 – Transfer of risks,
- A4/B4 – Carriage,
- A5/B5 – Insurance,
- A6/B6 – Delivery/transport document,
- A7/B7 – Export/import clearance,
- A8/B8 – Checking/packaging/marking,
- A9/B9 – Allocation of costs, and
- A10/B10 – Notices.
An overview of Incoterms 2020 for 11 Terms
Each Incoterm is explained in more detail below:
EXW – Ex Works or Ex-Warehouse: The seller is responsible for packing and delivering the goods. The cargo is transferred to the buyer while the freight is still at the seller’s location. The buyer is then responsible for exporting, shipping, and importing the cargo to its final destination.
FCA – Free Carrier: The seller is responsible for carrying the cargo to a specified location within the seller’s country, which is typically a shipping terminal. Once the cargo arrives at its destination, the package is transferred to the buyer, who must then pay the freight charges and complete the importing and delivery process. The cargo is exported by either the seller or the buyer, depending on the selected location.
FAS – Free Alongside Ship: The seller is responsible for managing the entire export process until the products arrive at the ship or other mode of transport. The risk is transferred to the buyer once the ship gets alongside. The buyer is liable for loading the cargo onto the vessel of their choice and transporting the items to their final destination.
FOB – Free On Board: The seller is accountable for supervising the entire export process and loading the products onto the ship. The products are transferred to the customer once the cargo has been successfully loaded. The buyer is liable for all import expenses as well as freight costs for transporting the goods to their destination.
CFR – Cost and Freight: The seller must carry the cargo to the buyer’s port. Once the items reach the port, the buyer takes responsibility. The buyer must next unload the cargo and import the items into the destination country, after which they must import and deliver to the final destination.
CIF – Cost, Insurance, and Freight: The seller bears the costs of shipping and insuring the goods to the buyer’s specified port. The buyer takes responsibility for the goods after they arrive at the port. The buyer is then responsible for the costs of unloading, importing, and delivering the shipment. CIF necessitates the purchase of freight insurance by the supplier.
CPT – Carriage Paid To: The seller is responsible for shipping and unloading the cargo from the vessel at the specified delivery location. When the products are unloaded, ownership of the cargo is transferred to the buyer, who is then responsible for importing and delivering the freight to its final destination.
CIP – Carriage & Insurance Paid: The seller must cover the costs of shipping and insuring the cargo to the specified location. After the cargo has been unloaded and brought to the terminal, it is sent to the buyer. Once the goods have been unloaded and brought to the designated terminal, the shipment is given to the buyer. To get the items to their final destination, the buyer must import them and complete the rest of the shipping process. The seller is required by CIP to acquire freight insurance.
DAP – Delivered at Place: The seller is responsible for delivering the cargo at the final, specified location. The cargo is transferred to the buyer once it has been delivered. The buyer is responsible for unloading the shipment from the truck. The buyer must also pay import duty, taxes, and customs clearance.
DPU stands for Delivered at Place. Unloaded: The seller is responsible for delivering and unloading the cargo at the ultimate destination. The buyer assumes responsibility once the shipment has been securely unloaded at the buyer’s warehouse. Import duty, taxes, and customs clearance are the responsibility of the customer.
The seller is responsible for delivering the cargo to the final destination as well as paying the import duty, taxes, and customs clearance. Once the cargo reaches its destination, the buyer is responsible for covering the costs of unloading the package. The only Incoterm requiring the seller to pay all duty costs is DDP.
Incoterms 2020 vs Incoterms 2010
The main ideas behind Incoterms® 2020 have stayed the same, but there have been a few important changes and updates. The main change is the replacement of DAT with a new DPU term, as well as the additional Incoterms® revisions listed below. It is important that everyone involved in international trade knows about these changes and how they might affect your supply chain.
DAT is replaced by the new Incoterm® DPU.
DPU (Delivered at Place Unloaded) replaces the earlier Incoterm® DAT (Delivered at Terminal). To avoid future confusion, it was agreed to alter the word to DPU. DAT previously needed ‘Delivery at Terminal (unloaded),’ but the term “terminal” caused confusion. The new term DPU (Delivery at Area Unloaded) refers to ‘any place, covered or not’.
CIF and CIP insurance coverage levels vary.
CIF and CIP are the only two Incoterms® that require the seller to buy insurance in the name of the buyer. Under Institute Cargo Clause C of Incoterms® 2010, insurance protection for CIF and CIP was required. CIP mandates insurance coverage in accordance with Institute Cargo Clause A under the new Incoterms® 2020. Clause A has a wider range of insurance options that are usually best for manufactured goods. Clause B, on the other hand, is more likely to apply to commodities.
- CIF stays the same; it necessitates ‘Institute Cargo Clause C’ insurance coverage – the number of identified risks subject to itemized exclusions.
- CIP now necessitates the purchase of an improved ‘Institute Cargo Clause A insurance policy – All risk, subject to listed exclusions.
Costs and Listings have been updated.
Costs became a major issue for several parties after the adoption of Incoterms® 2010. In some cases, carriers changed their prices, so sellers were often hit with new back-charged terminal handling fees. Incoterms® 2020 now includes substantially more detail about expenses and appears in the rule’s A9 and B9 parts. This clearly specifies which costs are assigned to which parties.
Increased Security Requirements, Allocations, and Costs
In a world where security requirements are rising, the Incoterms® 2020 guidelines now provide additional data on security allocations and associated expenses. The security allocations for each Incoterm® rule have been added to A4/A7, and the related charges have been added to A9/B9.
Buyer’s and Seller’s Own Transportation
Under Incoterms® 2010, it was believed that all transportation would be handled by a third-party transport provider. Incoterms® 2020 updates allow for the buyer or seller to provide their own mode of transportation. This recognizes that some buyers and sellers use their own modes of transportation, such as trucks or planes, to have products delivered.
- The FCA rule permits the buyer to use his or her own mode of transportation.
- Under DAP, DPU, and DDP, the seller may use his or her own transportation.
FCA, FOB, and the Bill of Lading Process
In actuality, most parties were still using FOB when they should have been using FCA. This is because even experienced sellers preferred FOB since they wanted the contract to be covered by a Letter of Credit.
So, the Incoterms® 2020 have been changed to say that the buyer must ask the carrier to send a document showing that the items have been loaded, such as a bill of lading that says “on board.” Before, carriers often wouldn’t give a Bill of Lading with a note to the seller if the items were bought from a middleman (like a truck) instead of the seller directly.
Understanding Incoterms Responsibilities
Not all Incoterms are applicable to all shipments. While all Incoterms are valid for waterway shipments, some are only valid for waterway transit and cannot be used for land or air transport. Knowing these differences is important because if you utilize a waterway only Incoterm and ship via another means, you may be required to pay additional, unexpected charges.
The following is a list of Incoterms that can be used for all types of transportation methods:
- EXW – Ex Works or Ex-Warehouse
- FCA – Free Carrier
- CPT – Carriage Paid To
- CIP – Carriage and Insurance Paid To
- DAP – Delivered At Place
- DPU – Delivered At Place Unloaded
- DDP – Delivered Duty Paid
The following Incoterms are exclusively valid for sea and inland waterway transport:
- FAS stands for Free Alongside Ship.
- CFR – Cost and Freight
- FOB – Free on Board
- CIF stands for Cost, Insurance, and Freight.
What is the difference between “Freight Collect” and “Freight Prepaid”?
When discussing international freight, the terms Freight Prepaid and Freight Collect are frequently used by buyers and sellers. When a vendor says “Freight Collect,” they are referring to one of four Incoterms that require the buyer to collect and pay all freight charges. Freight Collect Incoterms are as follows:
- EXW stands for Ex Works or Ex-Warehouse.
- FCA stands for Free Carrier.
- FAS stands for Free Alongside Ship.
- FOB stands for “Free on Board.”
The term “Freight Prepaid” suggests that the vendor will pay the freight charges. Freight Prepaid is one of the remaining seven Incoterms.
- CFR – Cost and Freight
- CIF – Cost, Insurance & Freight
- CPT – Carriage Paid To
- CIP – Carriage and Insurance Paid To
- DAP – Delivered At Place
- DPU – Delivered At Place Unloaded
- DDP – Delivered Duty Paid
When shipping under the CIF and CIP Incoterms, what kinds of insurance must a seller get?
Two international Commercial Trade Terms require the seller to get cargo insurance prior to shipment. These are the terms CIF and CIP. Each of these phrases has its own rules about what kind of insurance a seller needs to get.
- CIF, or Cost, Insurance, and Freight need an insurance policy with the Institute Cargo Clause’s minimum coverage (C).
- CIP, or Carriage & Insurance Paid To, requires an insurance policy with at least the Institute Cargo Clause coverage (A).
What are the consequences of improper Incoterms usage?
There are several consequences for using the improper Incoterms®, and users must completely know what a three-letter Incoterms® rule means when they include it in a sales contract. Most frequently, improper Incoterms® rules are applied as a result of
- Using inappropriate rules for the chosen mode of transportation;
- Failure to comprehend the division of costs and risks between the buyer and seller;
- Executing an incorrect version of the Incoterms® regulations;
- The lack of geographical specificity in the rules;
- Not being aware of what the Incoterms® regulations do and do not do;
- Choosing rules that do not meet the needs of the business;
Incoterms® rules were made to reduce the chance of misunderstandings and expensive disputes in local and international trade where sales contracts may not be written correctly. As the amount and complexity of international trade grow, so does the chance that Incoterms® standards will not be used correctly.
How do a buyer and seller decide which Incoterm to use?
Unless specifically requested by a buyer, sellers often have preferred Incoterms that work best for them and their consumers. Buyers often have unique preferences, which they communicate to sellers, and via this communication, a buyer and seller can reach an agreement on the best Incoterm for their deal.
Incoterms must be stated on the purchase agreement, sales invoice, or sales contract in order to be contractually valid. Because these are contractual terms, buyers and sellers should be specific in their agreements and not rely on verbal communication to specify each party’s responsibilities when shipping things worldwide.
When choosing an Incoterm, no particular documentation or form is required; instead, the term should be put alongside the product price and described as the agreed-upon incoterm.
During the order process, Incoterms may alter. For example, an Incoterm can be changed if a package was supposed to be sent by sea but has to be sent by air because of a delay or something else that came up. As previously stated, not all terms apply to air travel. If the terms change, buyers and sellers must talk about it in a purchase agreement the same way they would talk about any other change.
How to Prepare Your Firm for Incoterms 2020?
As Incoterms® is updated, it is important to consider how any changes may affect your organization. It is much better to be proactive rather than reactive if major problems emerge with any of your orders or shipments. Before making any modifications to your business, always seek expert legal guidance. Here are a few things to think about as you prepare for the changes:
- Determine the Incoterms® that your company commonly employs.
- Examine any contracts that have been extended or renewed in 2020.
- If you are purchasing or selling using a Letter of Credit, you may want to consider using FCA instead of FOB. It will be necessary to instruct carriers to issue Bills of Lading. Before making any changes, always get expert legal guidance.
- Make any necessary adjustments to any contracts and paperwork.
- In sales contracts, make sure to provide the Incoterms® edition year to which both parties are referring.
- Examine the new pricing and listings to determine whether it affects your landed cost calculations.
- Increase your insurance coverage to meet the new CIP standards.
- Import and export security should be strengthened.
- Determine who is responsible for loading and unloading fees.
- Understand where the risk of loss is transmitted.
- To evaluate current methods, you can hire experienced supply chain and legal analysts to give you legal advice.
How to Implement Incoterms 2020 in Sales Contracts?
The new Incoterms® 2020 became effective on January 1, 2020. What does this actually mean for your company? Trading partners can continue to utilize Incoterms® 2010 if they prefer, which may occur when it is employed to confirm complex commercial agreements.
To avoid misunderstandings, all parties must make it clear in contracts which Incoterms® version is being referred to. Different trading partners will adopt Incoterms® into contracts at different times.
It is critical that you review previous contracts to ensure that the Incoterms® edition year is included. If no year is specified, the following will apply:
- Incoterms® 2010 is valid until December 31, 2019.
- Incoterms® 2020 is effective from January 1, 2020.
- If a different year is specified, such as Incoterms® 1990, the relevant terms will apply.
Below is the structure that should be used on Sales Contracts:
[Incoterm® rule] [Named port/place/point] Incoterms® 2020
CIF Longbeach Incoterms® 2020
DPU 4300 Longbeach Blvd, Longbeach, United States Incoterms® 2020
To conclude, when using Incoterms, it’s important to pay close attention to the terms of the contract because they can have a big effect on the costs and risks of delivering goods. Also, it’s a good idea to talk to a lawyer or other professional to make sure that the contract’s terms are clear and reflect the parties intentions.
The views expressed in this article are the author’s own and do not reflect WorldRef’s views, opinions or policies.
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