Incoterms: A Complete Guide 2023

With the ever-increasing globalization, international shipping and imports are increasing rapidly as well. When you export or import goods to or from abroad, you have to deal with International Commercial Terms & Conditions or International Commercial Terms. Besides, these terms are referred to as Incoterms as well.

In short, Incoterms are a set of globally recognized trade terms developed by the International Chamber of Commerce (ICC). These terms are used to ease international trade by providing a common language and understanding of the responsibilities, costs, and risks involved in the transportation and delivery of goods.

Additionally, Incoterms are revised every decade. That way, 2020 brought new changes and updates to the terms. So, whether you are new to using Incoterms or have been using it for some time, you should know the updated terms related to international shipping. Incoterms A complete guide will provide an in-depth overview of Incoterms, including their history, purpose, structure, and explanations of each term.

Purpose and Benefits of Incoterms

1. Clarity and Consistency: Incoterms provide a standardized language for buyers and sellers in international trade. As a result, it makes sure that both parties have a clear understanding of their respective obligations, costs, and risks.
2. Simplification of Contracts: By using Incoterms, parties can simplify their contracts by referring to a specific term rather than outlining every detail related to the delivery of goods.
3. Risk Management: Incoterms help parties manage risks by clearly defining when the risk of loss or damage to the goods transfers from the seller to the buyer.
4. Reduction of Disputes: By providing clear definitions and guidelines for the responsibilities of buyers and sellers, Incoterms reduce the likelihood of disputes arising from misunderstandings or misinterpretations.

Structure of Incoterms

1. Grouping: Incoterms are grouped into two main categories based on the mode of transport: a. Group 1: Incoterms applicable to any mode of transport (sea, air, rail, or road) b. Group 2: Incoterms specific to sea and inland waterway transport
2. Three-Letter Abbreviations: Each Incoterm is represented by a three-letter abbreviation that is universally recognized and understood in international trade.
3. Obligations: Each Incoterm outlines the specific obligations of both the buyer and seller concerning the delivery process, including carriage, insurance, export/import clearance, and payment of transportation costs.

Why does Incoterms matter?

When there is any kind of commercial interaction in terms of physical goods, Incoterms are important elements. The terms dictate what the seller is proposing when it comes to liability and cost.

Suppose, you have a sourcing project, where one supplier quotes using DDP and another EXW. So, the one with EXW seems a better deal even though the bids appear similar. When it comes to international trade, a difference in the letter DDP and DAP could make a difference. The cost can go higher up to 25% depending on the tariff rates and codes for the specific goods.

Therefore, an Incoterm strategy at the executive level is important for the VP or Chief Procurement Officer to have a standardized set of instructions regarding risks associated with logistics. Although rare, undesirable situations may happen. When goods get destroyed, lost, or stuck during transit, you have to look at your Incoterms to find out who is liable to get it fixed.

Benefits of using Incoterms:

Incoterms are binding agreements between the seller and buyer. It outlines the responsibilities between the purchaser and manufacturer of goods concerning the delivery of products. However, a seller doesn't need to provide Incoterm when it comes to selling internationally.

But the advantage of doing so can prevent confusion over certain responsibilities and important roles to play between the two parties involved in the transaction. No wonder, international trade involves cultural differences and language barriers.

So, the Incoterm simplifies the complicated process of communicating effectively during the transportation of goods. As such, it helps both the buyers and sellers. Therefore, understand Incoterm so that you do not have to bear costly misinterpretations or misunderstandings.

What are the functions of Incoterms?

By now you have understood the importance of Incoterms and how they are an integral part of international shipping of goods. Below listed are the functions of Incoterms.

• Cost allocation – Which party bears the risk relating to costs?
• Risk transfers – Which party would be liable to undertake the risks and under what circumstances?
• Division of obligations – Which party will take the obligations and on which routes?
• Customs – Which party is liable for clearance of customs?
• Goods documents – Which party will buy the goods documents?
• Transport documents – Which party will buy what type of transport documents?
• Packaging – Which party will determine the packaging type and method?
• Goods inspection – Which party will be liable to carry out the task of inspecting goods?
• Information – Which party will inform the other about what and what time?
• Shipping insurance – Which party will insure goods and for what part of the transit?

How do a seller and a buyer agree on what Incoterm to use?

If a buyer does not have a specific request, the seller will offer the preferred Incoterms that they believe will work best for them and their buyers. Buyers will have different preferences and they are addressed to the sellers. The buyer and seller can effectively communicate with each other and arrive at an agreement that suits both parties.

They will have the best Incoterm for the deal. If the Incoterms need to remain valid, the sales contract, sales invoice, and purchase agreement should list the terms. Because the terms are purely contractual, both buyers and sellers should be clear about the agreement. Moreover, they do not have to rely on verbal communication and discuss the responsibilities of each party when the shipment is for other countries.

On top of that, there are no specific forms or documentation when it comes to choosing an Incoterm. But the terms should be listed in connection with the price of products and treated as agreed-upon Incoterms. Furthermore, Incoterms can alter during the order process in some cases.

For example, consider a shipment intended for a sea route. But for certain unforeseen circumstances or delays, the shipment has to be sent by air. In that case, the Incoterm has to be changed. Also, not every term will be valid for air travel. Whenever there is a change in terms, sellers and buyers have to communicate and acknowledge such changes. This is similar to a situation when there needs an alteration to settle flaws in the purchase agreement.

What is the complete Incoterm?

The complete Incoterm is a set of standardized trade terms that define the obligations, risks, and costs associated with the transportation and delivery of goods between buyers and sellers. The Incoterm specifies who is responsible for each stage of the transportation process, including loading, unloading, and customs clearance. It also specifies who is responsible for any associated costs, such as insurance, taxes, and duties.

How do you write a complete Incoterm?

To write a complete Incoterm, you must include the following elements:

The name of the trade term (e.g., EXW, FOB, CIF)

The place of delivery (e.g., port of loading, warehouse)

The mode of transportation (e.g., sea, air, road)

The point at which risk transfers from seller to buyer (e.g., at loading, at delivery)

The party responsible for each stage of the transportation process (e.g., loading, unloading, customs clearance)

The party responsible for any associated costs (e.g., insurance, taxes, duties)

By including these elements in your Incoterm, you can ensure that both the buyer and seller understand their respective obligations and responsibilities throughout the transportation and delivery process.

What are the 6 basic Incoterms?

The 6 basic Incoterms are:

1. EXW (Ex Works): This term places the most responsibility on the buyer, who is responsible for all transportation and delivery costs from the seller's warehouse or factory.
2. FCA (Free Carrier): This term requires the seller to deliver the goods to a specified carrier or location, but the buyer is responsible for all transportation costs from that point.
3. CPT (Carriage Paid To): This term requires the seller to pay for transportation to a specified location, but the buyer is responsible for any additional costs and risks from that point.
4. CIP (Carriage and Insurance Paid To): This term is similar to CPT but requires the seller to provide insurance for the goods during transit.
5. DAP (Delivered At Place): This term requires the seller to deliver the goods to a specified location, but the buyer is responsible for unloading and any further transportation or customs clearance.
6. DDP (Delivered Duty Paid): This term places the most responsibility on the seller, who is responsible for all transportation and delivery costs, as well as any taxes, duties, or customs clearance fees.

What are the 4 most used Incoterms?

The 4 most used Incoterms are:

1. EXW (Ex Works)
2. FOB (Free on Board)
3. CIF (Cost, Insurance and Freight)
4. DAP (Delivered At Place)

EXW is often used for domestic sales or when the buyer has a high level of expertise in international trade. FOB is commonly used for sea freight shipments and requires the seller to load goods onto a vessel at a specified port. CIF is also used for sea freight shipments and requires the seller to provide insurance for the goods during transit. DAP is often used for air freight shipments and requires the seller to deliver goods to a specified location, but the buyer is responsible for unloading and any further transportation or customs clearance.

Conclusion

Incoterms play an essential role in international trade by providing standardized terms. It defines the responsibilities, costs, and risk allocation between buyers and sellers in cross-border transactions. Understanding each Incoterm is crucial for negotiating contracts that accurately reflect each party's obligations while minimizing potential disputes or misunderstandings.

By familiarizing yourself with Incoterms and applying them correctly in your international trade transactions, you can ensure smoother communication with your trading partners, reduce potential disputes, manage risks more effectively, and ultimately achieve more successful outcomes in your global business endeavors.

With this comprehensive guide to Incoterms as your resource, you can confidently navigate international trade with clarity on each term's implications for both buyers and sellers alike – ultimately leading to more efficient transactions in today's global marketplace.

EXW (Ex Works)

a. Seller's Obligations:

i. Make the goods available for collection at their premises or another specified location.

ii. Provide any necessary documentation for the buyer to pick up the goods.

b. Buyer's Obligations:

i. Arrange and pay for transportation and insurance.

ii. Obtain any necessary export/import licenses or permits.

iii. Assume all risks and costs once the goods are made available for collection.

iv. Handle export clearance.

FCA (Free Carrier)

a. Seller's Obligations:

i. Deliver the goods to a specified carrier at a designated location.

ii. Provide export clearance.

iii. Bear all risks and costs until the goods are delivered to the carrier.

b. Buyer's Obligations:

i. Arrange and pay for transportation and insurance after delivery to the carrier.

ii. Obtain any necessary import licenses or permits.

iii. Assume all risks and costs once the goods are delivered to the carrier.

CPT (Carriage Paid To)

a. Seller's Obligations:

i. Arrange and pay for transportation to a specified destination.

ii. Provide export clearance.

iii. Bear all risks and costs until the goods are delivered to the first carrier.

b. Buyer's Obligations:

i. Pay for insurance.

ii. Obtain any necessary import licenses or permits.

iii. Assume all risks and costs once the goods are delivered to the first carrier.

CIP (Carriage and Insurance Paid To)

a. Seller's Obligations:

i. Arrange and pay for transportation and insurance to a specified destination.

ii. Provide export clearance.

iii. Bear all risks and costs until the goods are delivered to the first carrier.

b. Buyer's Obligations:

i. Obtain any necessary import licenses or permits.

ii. Assume all risks and costs once the goods are delivered to the first carrier.

DAP (Delivered At Place)

a. Seller's Obligations:

i. Arrange and pay for transportation to a specified destination.

ii. Provide export clearance.

iii. Bear all risks and costs until the goods are made available for unloading at the destination.

b. Buyer's Obligations:

i. Pay for insurance.

ii. Obtain any necessary import licenses or permits.

iii. Handle import clearance.

iv. Assume all risks and costs once the goods are made available for unloading at the destination.

DPU (Delivered At Place Unloaded)

a. Seller's Obligations:

i. Arrange and pay for transportation to a specified destination.

ii. Provide export clearance.

iii. Bear all risks and costs until the goods are unloaded at the destination.

b. Buyer's Obligations:

i. Pay for insurance.

ii. Obtain any necessary import licenses or permits.

iii. Handle import clearance.

iv. Assume all risks and costs once the goods are unloaded at the destination.

DDP (Delivered Duty Paid)

a. Seller's Obligations:

i. Arrange and pay for transportation to a specified destination.

ii. Provide export clearance.

iii. Handle import clearance and pay any applicable duties or taxes. iv.Bear all risks and costs until the goods are made available for unloading at the destination.

b. Buyer's Obligations:

i. Pay for insurance.

ii. Assume all risks and costs once the goods are made available for unloading at the destination.

Group 2: Incoterms Specific to Sea and Inland Waterway Transport

1. FAS (Free Alongside Ship)

a. Seller's Obligations:

i. Deliver the goods alongside the vessel at a specified port.

ii. Provide export clearance.

iii. Bear all risks and costs until the goods are alongside the vessel.

b. Buyer's Obligations:

i. Arrange and pay for transportation and insurance from alongside the vessel onwards.

ii. Handle loading onto the vessel.

iii. Assume all risks and costs once the goods are alongside the vessel.

2. FOB (Free On Board)

a. Seller's Obligations:

i. Deliver the goods on board the vessel at a specified port.

ii. Provide export clearance.

iii. Bear all risks and costs until the goods are on board the vessel.

b. Buyer's Obligations:

i. Arrange and pay for transportation and insurance from on board the vessel onwards.

ii. Assume all risks and costs once the goods are on board the vessel.

3. CFR (Cost and Freight)

a. Seller's Obligations:

i. Arrange and pay for transportation to a specified port of destination.

ii. Provide export clearance.

iii. Bear all risks until the goods are on board the vessel at origin port.

b. Buyer's Obligations:

i. Pay for insurance from on board the vessel onwards.

ii. Assume all risks from on board the vessel onwards.

4. CIF (Cost, Insurance, and Freight)

a. Seller's Obligations:

i. Arrange and pay for transportation, insurance, and freight to a specified port of destination.

ii. Provide export clearance.

iii. Bear all risks until the goods are on board the vessel at origin port.

b. Buyer's Obligations:

i. Assume all risks from on board the vessel onwards.

What is new in Incoterms 2020?

• The Bill of Lading or BL – The BL option is added to FCA and the same could be specified in the sales agreement about the issuance of the Bill of Lading. Besides, the Bill of Lading or BL indicates that the goods are loaded and on board. The buyer has to instruct the carrier about handing over the so-called ‘note of board’ to the seller.
• Alteration in DAT – Delivered at Place Unloaded or DPU is the new term to be used in place of the old term Delivered at Terminal or DAT. The main reason for changing is that goods can be delivered either to a dock or terminal. However, it is not limited and the same could be delivered at other points, too. For example, at places such as warehouses or factories where it is possible to unload goods.
• The CIP and CIF will have different coverage levels. In the case of CIP, sellers need to opt for comprehensive transport insurance. Whereas for CIF, minimum insurance coverage is obligatory.
• DPP, DPU, DAP, and FCA will have separate means of transportation. These Incoterms allow for the arrangement of goods transportation with individual means of transport.