Have you ever thought, how you can save money by choosing the right incoterms and payment terms?
This article will answer this question for you.
When dealing with international trade, learning about trade terms is a very important subject. When you communicate with the suppliers about shipment terms, they may sometimes ask you, do you want FOB or EXW, or may use other terms as well.
If you do not understand these terminologies and ask the suppliers, this will give them an expression that you are very new to this industry and hence this may make you a target to some scam.
This article will discuss each term in detail and will help you make the right decision.
Table of Content
1) Definition of Incoterm
2) EXW – Ex-works or Factory Incoterm
3) FOB – Freight on Board Incoterm
4) CIF – Cost Insurance and Freight Incoterm
5) DDP – Delivered Duty Paid Incoterm
6) FCA – Free Carrier Incoterm
7) CPT – Carriage paid to or Port Paid-up Incoterm
8) CIP – Carriage and Insurance paid to Incoterm
9) DAT – Delivered at Terminal Incoterm
10) DAP – Delivered at Place Incoterm
11) Definition of Payment Terms
1) Definition of Incoterm
In short, incoterms mean International Commercial Terms and these are useful in making an agreement between the buyers and the sellers for the international trade contracts. These incoterms are represented by 3 letter acronyms and define the sellers’ obligations and buyers’ obligations and at what stage the responsibility of the products and their shipment is transferred to the other party.
Currently, there are 11 incoterms that are most commonly used. There are two times of incoterms. Those applying to modes of transport and those applying to maritime and inland waterway transport. These terms determine the 4 important aspects of an export and import operation.
- The precise place where the goods are going to be delivered.
- Who will process each of the documents that are generated in the chain from origin to destination?
- At what point in the transaction the risk is transferred from the seller to the buyer.
- Establishes what costs in the logistics chain are paid by the seller and which are paid by the buyer.
We will talk about the most commonly used Incoterms in detail and understand their meaning, but before we go into further explanation of the incoterm, let us have a look at some common trade terms.
Definition – Trade Terms
Before we get into the incoterms, there are a few words that need to be defined:
Seller: Typically the manufacturer, trading company, or wholesaler who is supplying the goods for sale.
Buyer: The person who is purchasing the goods and will receive them upon final delivery.
Delivery: The point in the process in which the risk is transferred from seller to buyer.
Arrival: The point when the delivery has been paid. The place should be named by the seller.
Free: How far the seller has an obligation to deliver the goods to be picked up by the buyer.
Carrier: The party that is obligated to transport the goods. This can be done by any means necessary for instance as ship rail or truck.
Freight Forwarder: A firm that is commonly contracted to make shipping arrangements.
To clear for export: When export permission is granted.
Terminal: The final destination of the shipment; such as a dock or warehouse. For FBA sellers this is most commonly an Amazon fulfillment center.
Let us first start with the most commonly used terms which are EXW, FOB, CIF, and DDP.
2) EXW = Ex-Works or Factory Incoterm
This is by far the most basic shipping incoterm when you need to get the lowest cost. Because this is the initial cost and all the other costs in the product will be added after this. We can also call it a factory price. It means that the supplier needs to quote the price of the product as it’s made in the factory or you pick the goods from the warehouse.
Once you take the goods, all the responsibility and risk is passed on to you now. You need to arrange logistics within China, do the customs declaration, ship to your destination country, and do the customs clearance in your country.
It is always better to get the Ex-works price from the factory first and then calculate each cost from there on so you can know which stage you can save the cost. However, your cost will be saved but it will also give you more risks to bear.
3) FOB – Free On Board Incoterm
FOB incoterm means that the supplier will ship the goods to the nearest port and will provide you the cost of that. It mostly includes the product cost and logistics cost to the port. After that, the seller needs to work with the freight forwarder and do the customs declaration and ship the goods to the destination of the buyer. Once the goods are loaded on the ship, the responsibility is then transferred to the buyer. He will bear the ocean freight, insurance, unloading charges and customs clearance, import duties and taxes, and inland transportation.
4) CIF – Cost Insurance and Freight Incoterm
The seller will deliver the goods, clear them for export; onboard the vessel at the port of the shipment in the seller’s country pays for the transport of the goods to the port of the destination, also obtains and pays for insurance for the goods during the shipment until it arrives at the buyer’s country.
The buyer assumes all risks once the goods are on board the ship, however, he will not take on any costs until the goods arrived at the destination port.
5) DDP = Delivered Duty Paid Incoterm
Delivered, duty paid is by far the most famous one used by the buyers because this will put all the risk on the seller. The seller will have to make sure that the products are shipped from the seller’s country, shipped, insured and once it arrives at the buyer’s country, the seller will also be responsible to make customs clearance and pay the duty. So this means that from the factory to the buyer’s home or warehouse, all responsibility is borne by the seller.
This is also called a door to door delivery.
The following are the incoterms that are not very commonly used but it is important to understand them as well.
6) FCA = Free Carrier Incoterm
When using this term, a place is defined between the seller and the buyer. This place can be the seller’s warehouse or of forwarder or carrier. The seller’s responsibility will lie in this place. Once the goods are delivered at this place, from then onwards the buyer will bear all the risks and responsibility.
The buyer will have to pay for the delivery of goods from the warehouse to the port, terminal and loading charges, ocean freight, insurance, unloading at the destination port, clearance, and then inland transportation to the buyer’s warehouse.
7) CPT = Carriage Paid To or Port Paid Up Incoterms
In CPT terms, the seller will deliver the goods at their own expense bearing all the risk, to a carrier, freight forwarder, or another person nominated by the seller. The seller assumes all the risks, loss, thefts, damage to the goods until the goods are in the care of the nominated party.
8) CIP = Carriage and Insurance Paid Incoterm
As per this arrangement, the seller is responsible for the delivery of goods to an agreed destination in the buyer’s country. The seller also has to pay for the cost of this carriage.
The risk of the seller will end once the goods have been placed on the ship at the origin-destination which will be the country that is exporting the goods.
9) DAT = Delivered At Terminal Incoterm
This means that the seller clears goods for export and is also takes full responsibility for the goods until they have arrived at the terminal at the final destination mentioned by the seller.
The seller will also be responsible for unloading the goods at the terminal.
10) DAP = Delivered At Place Incoterm
Under the DAP incoterms rules, the seller will be responsible for the delivery of the goods, make them ready for unloading, at the named place of destination provided by the buyer. The seller will bear all risks involved up to unloading.
After that, the buyer will take responsibility for unloading the goods.
These were some of the important and commonly used terms and we believe that you will have a good understanding after going through this chapter. Make sure that you have clear communication with the supplier on what terms to use and understand each term’s advantages for you related to cost and time.
11) Payment Terms
Payment terms mean that how the buyer and seller have agreed to make and collect the payment. When you build long term relationships with the Chinese suppliers, you may get a lot of benefits on the payment terms and this can result in providing you a lot of convenience for your business.
The payment method and the process can have a major impact on the outcome. Let us talk about the most common payment terms used in China.
The general rule in China which most of the suppliers will use is 30% deposit and 70% balance. It means that you first make the payment of 30% as a deposit. The seller will only start the production after they receive the deposit. Once the goods are ready, you may choose to visit the factory and make an on-site inspection or use a 3rd party company to do so. Then you can make the final payment of 70% balance against the documents of the shipment.
Sometimes, when you customize the product, the supplier will insist you make 100% payment and they do have a good reason for it as well. Customization of the product means that you will have your own brand on it, your logo, your own colors. So the product will become unique to you.
Now if you make the 30% deposit and the seller produces the whole batch and for any reason, you are not able to pay the remaining 70% deposit. It will be a huge loss for the seller because the products are under your brand.
It will not be possible for the supplier to sell it further through his other channel. This is not the case in an unbranded product or the product under the supplier’s brand.
A point to note here is that once the supplier’s finished the goods, he will already have incurred more money on the production than the 30% deposit he received. These are all those reasons due to which he will insist on getting 100% upfront payment.
You may choose to negotiate and put a contract in place which will ensure the supplier that you will pay the balance payment. You may also choose to increase the percentage of deposit to 50% or at any level where the supplier is satisfied.
However, this will not be the case with every supplier. Some of them will be very happy to take a 30% deposit and start production.
If you have a long-term and trustable relationship with the supplier, you may request the supplier to provide you a credit line. The amount of credit can be negotiated. Some suppliers who see you as their main customer and will not want to lose you will also accept to produce and even ship the goods without receiving any payment and can provide your credit lines for up to a few months.
However, this is very rare since the value of such orders is really huge. Therefore getting a credit line is only possible if you have a very strong and trustable relationship with the supplier.
- Never pay any deposit before you have got the contract signed and stamped.
- Never pay any balance until you have inspected the goods, you are satisfied with the quality.
- Do not under any circumstances pay 100% payment. In this way, all the power will be shifted in the seller’s hands. He may choose not to remake or repair defective or non-compliant items.
- Make sure that when you are paying the balance, the goods are directly shipped or move from the factory or warehouse. It may be possible that when you pay the balance, a supplier may choose to put exchange inferior quality goods with your shipment.
We can easily say that knowing the right incoterms and payment terms can help you a lot when working with Chinese suppliers. By reading this chapter you must have learned that the advantages and disadvantages of the most commonly used incoterms and payment terms and it will help you to choose the right one for your business.