Shipping Incoterms: What are They, and Why are They Used?

Why do you need to understand Shipping Incoterms if you are shipping internationally?

It makes no difference if you are new to international trading or have years of expertise. Choosing the correct Incoterm rule can be difficult. Because selecting the wrong term can leave you accountable for transportation and other fees, which you don’t want to include in the pricing of your goods.

Although the vast majority of American businesses ship domestically using the conditions specified in the U.S. uniform commercial code (UCC). Let us tell you that these shipping terms are inappropriate when exporting.

When shipping overseas, the terms you use for domestic shipments have different meanings. For instance, domestic shippers widely use the version of the word “FOB” (Free On Board). For instance, it has an entirely different meaning in that setting. Therefore, it is inappropriate worldwide. Not only are shipping Incoterms 2020 rules different for both scenarios, but the abbreviations also may make them even more puzzling and challenging to understand.

This article will go through Incoterms 2020. We will briefly go through what shipping Incoterms are and how they came into existence, how to use them, how they assist exporters and importers, and why they are essential.

Chapter 1: Shipping Incoterms Explained

1) What is an Incoterm?

The International Chamber of Commerce (ICC) releases a collection of shipping Incoterms to support global trade. Officially, these terms are known as International Commercial Terms.

Incoterm shipping terms are globally recognized for identifying the rights of buyers/sellers for the delivery of items under sales contracts for international trade and are adhered to by text. The Incoterms have a high agreement level with the United Nations Convention on Contracts for the International Sale of Goods. All major trading nations are familiar with and use Incoterms shipping.

Incoterms are merely one part of the entire export contract. They don’t mention the price you pay, the date of payment, or the form of payment the transaction is using. Moreover, Incoterms 2020 guidelines do not address the transfer of ownership of goods, breach of contract, or product liability; all of these concerns are handled in the sales contract. Furthermore, Incoterms 2020 regulations cannot replace any local country’s laws.

2) Origin of shipping Incoterms

A standard set of regulations was required due to differences in trading practices and legal interpretations among traders of different countries. These regulations needed to be simple for all participants to avoid misunderstandings, disagreements, and lawsuits.

The ICC proposed Incoterms in 1921, and the first Incoterms rules were developed in 1936. In 1936, they were officially labeled as Incoterms. Incoterms have since matured into a defined worldwide contractual standard. They are updated when major international trade events take place. In 1953, 1967, 1976, 1980, 2000, 2010, and 2020, amendments and additions were implemented to shipping Incoterms.

3) Who Defines Shipping Incoterms?

Thirteen ICC commissions comprised of international private-sector professionals make these international trade terms. These folks have expertise in everything from the most pressing issues to global business. Hence, being in charge of an international standard is not an easy task.

The ICC modifies the shipping Incoterms every ten years to ensure that they remain consistent with the current process of international trade.

4) How are Incoterms Rules Revised?

As stated by the ICC, “The group is composed of specialists from various nationalities chosen for their remarkable contribution to international commercial law and the International Chamber of Commerce throughout the years.” The Incoterms 2020 drafting committee was responsible for rewriting the Incoterms rules. It was led by co-chairs Christoph Martin Radtke and David Lowe.

Following changes by the drafting group, the new versions were distributed regionally and internationally via ICC National Committees, ensuring comments and recommendations were sent back to the drafting group.

The goal of the international consultation was to ensure that official ICC products have authority and represent the actual opinion of the global business sector.

Chapter 2: What do Shipping Incoterms define?

1) Point of Delivery (POD)

This section specifies where the products will be transferred from the seller to the buyer.

2) Import and Export Requirements

Each term specifies whether the seller or buyer is accountable for covering fees and facilitating the cargo’s export and import.

3) The responsible party of freight insurance

Freight insurance is required under various Incoterms. Each Incoterm will specify who is responsible for paying for freight insurance.

4) The responsible party for transportation costs

The section specifies who will pay for the freight. This element is commonly referred to as freight prepaid or freight collected.

Chapter 3: Shipping Incoterms Rules 2020?

1) Where can you learn about Incoterms Rules?

Every ten years, the International Chamber of Commerce updates Incoterms. While firms like sourcing companies rely on staying up to date with the ICC’s terms, you can learn more about the rules by visiting the ICC website.

If your job requires you to learn and apply Incoterms, you should get a copy of ICC’s Incoterms® 2020 book. Register today for an Incoterms® 2020 Rules webinar from International Business Training if you need help determining which term or terms your company should use in international transactions.

2) Shipping Incoterms Rules 2020 Defined

The mentioned changes have been made in the most recent revision:

• Incoterms 2020 guidelines allow sellers to use their transportation to distribute products. The terms now specifically mention that sellers may enter into a carriage contract or arrange for necessary transportation.
• The Incoterms 2020 guidelines now clearly call out import and export security standards and identify who is responsible for meeting those criteria, whether the buyer or seller.
• The most apparent change from Incoterms 2010 is renaming Delivered at Terminal (DAT) to Delivered at Place Unloaded (DPU).
• The most crucial modification from the 2010 guidelines is the definition of “Free Carrier” (FCA). Under FCA, a buyer can now ask their carrier to issue a bill of lading to the seller with an onboard notation to satisfy the terms of a letter of credit.
• The seller is now responsible for buying a higher level of insurance coverage—at least 110% of the value of the goods as specified in Clause A of the Institute Cargo Clauses—under the updated term CIP. CIF’s insurance requirement has not changed.

Shippers have the option to use early versions of incoterms rules. But, no one recommends doing so. Suppose you are not utilizing Incoterms 2020 rules. In that case, you must declare which version you are using and ensure your documentation is correct throughout the transaction.

 Chapter4: What’s Not Included in Shipping Incoterms You Need to Be Aware of as a Buyer?

Shipping Incoterms help explain a big chunk of the logistics and cargo moving process, which is why most international traders rely on them. Misunderstandings and expensive blunders could easily result from poor communication. As Incoterms express a lot, there’s much information that Buyers should understand not only what these terms mean but also what is not covered in these terms.

International Commercial Trade Terms help to express the delivery terms for a product bought abroad. These terms do not specify a product’s payment conditions or any other third-party rights. They don’t determine how the buyer should pay for the goods or define who is in charge of the cargo if the production is flawed, inaccurate, or unsuccessful.

Incoterms are not meant to protect buyers from fraud or guarantee the products. The main thing that Incoterms specify is who is in charge during the transportation procedure. Incoterms also communicate a portion of the purchase agreement to both parties, other than serving as a contractual agreement for the item.

Understanding if Incoterms protect buyers from the danger of cargo damage, loss, or theft can be a tricky issue for some buyers. Even though each Incoterm may serve to clarify each of these difficulties, only two Incoterms require a seller to purchase Insurance on the cargo. The purchaser would be required to buy Insurance on the cargo separately unless shipping insurance was agreed upon before a shipment.

Chapter 5: Advantages of Using Shipping incoterms

Incoterms are legally valid agreement between the buyer and seller that explains the responsibilities of the supplier and purchaser of goods in terms of product delivery.

Everyone in your organization involved in foreign transactions should be aware of the shipping Incoterms. This includes your purchasing agents and buyers if you are an importer. If you are an exporter, your international sales staff is comprised. Whether you are a seller or a buyer, your accounting department, logistics and transportation departments, senior managers, and others are all included.

When a seller and a buyer agree to use an Incoterm, both parties accept the related obligations and responsibilities as stated and specified in that Incoterm. Incoterms reduce the risk of legal issues by providing buyers and sellers with a single point of reference for trade procedures.

Even though sellers are not required to specify an Incoterm when selling overseas, doing so helps avoid confusion between the two parties duties and responsibilities. Because language difficulties and cultural differences are common in international trade, these terms help to simplify and communicate a large portion of the process of transferring products from supplier to buyer. Consider working with a China freight forwarder if you’re new to importing and incoterms to avoid costly misunderstandings.

If you use Incoterms correctly, you can partner more cooperatively, transport and deliver your items more efficiently, and get paid more quickly.

Chapter 6: More Information On Shipping Incoterms

1)  Difference Between Freight Prepaid and Freight Collect

When discussing international shipment, buyers and sellers commonly use the terms Freight Prepaid and Freight Collect. When a seller says “Freight Collect,” they refer to one of four Incoterms requiring the buyer to collect and pay all freight charges.

The Incoterms listed below are only applicable to sea and inland waterway transport.:

• EXW – Ex Works or Ex-Warehouse
• FCA – Free Carrier
• FAS – Free Alongside Ship
• FOB – Free on Board

The term “Freight Prepaid” suggests that the seller 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

2) How do Seller and Buyer Agree on a Shipping incoterm

Sellers generally have preferred Incoterms they use that work best for them and their clients unless specifically asked by a buyer. A buyer and seller can agree on the best Incoterm for their transaction through communication. Buyers commonly have specific preferences that they convey to sellers.

For Incoterms to be legally valid, The terms should be stated on the purchase agreement, sales invoice, or sales contract because these terms are contractual. Buyers and sellers should be specific in their agreement and not rely on verbal communication to define each party’s responsibilities when exporting goods internationally.

When choosing an Incoterm, no particular paperwork or form is required; the term should be stated alongside the item’s price and specified as the agreed-upon Incoterm.

During the process of an order, Incoterms may change. An Incoterm might change, for instance, if a shipment was meant to be transported by sea but is now shipped by air due to delays or unexpected circumstances. Not all terms apply to air travel, as we covered above. Buyers and sellers should inform one another if the terms were to change. Just like they would with any other change to a purchase agreement.

3)  What type of Insurance is needed before shipment?

Two International Commercial Trade Terms demand that the seller get cargo insurance before shipment. These are the terms CIF and CIP. Each of these phrases requires the type of Insurance a seller must acquire.

• CIP, which stands for “Carrying and Insuring Paid To,” needs an insurance policy that covers at least the Institute Cargo Clause(A).
• CIF, which stands for Cost, Insurance, and Freight, needs an insurance policy covering at least the Institute Cargo Clause (C).

4) Shipping incoterms in Domestic Sales

Since they use Incoterms for international sales, some companies have used them for domestic sales instead of the Uniform Commercial Code (UCC) terms. Using shipping Incoterms is acceptable as long as the contract clarifies the terms the buyer and seller utilize.

Chapter 7: Definitions of Shipping Incoterms

Not all Incoterms are suitable for all shipments. While all Incoterms are valid for canal shipments, some are only valid for waterway transport and cannot be used for land or air transport. Knowing these differences is important because if you apply a waterway only Incoterm and ship via another means, you may be required to pay additional, unexpected charges.

Incoterms 2020, the most recent modification of the terms, went into effect on January 1, 2020, and consists of 11 Incoterms.

1)  The following is a collection of Incoterms that can be used for all types of shipment procedures

• EXW (Ex Works):

The seller performs its duties by making the products available for the buyer to pick up at its location or another specified location (such as a factory, warehouse, etc.) on a day or within a time agreed upon by the parties. The seller must provide the buyer with all the information required to take delivery of the products at that time.

The term “ex-works” means that the buyer bears all risk and expenses from the time the goods are made accessible to the customer at the seller’s or another stated location until the items are delivered to their location. The seller is not required to pack the products or export-clear them.

Although the U.S. Export Administration and Foreign Trade Regulations do not exclude sellers from export compliance, Ex Works is the only Incoterm that makes export clearance the buyer’s responsibility. Even under Ex Works, the seller must give specific information about the transaction to the buyer’s freight forwarder or another authorized party who has been permitted to use AESDirect to submit the electronic export information.

• FCA (Free Carrier):

The seller should make the products available on its property or at a specified location. In either situation, it is the seller’s responsibility to load the goods onto the buyer’s transport, deliver them to the port, and take care of export clearance, including any security needs. Once the products are loaded onto the buyer’s transportation, the risk is shifted.

The Incoterms 2020 rules have modified this term the most. FCA used to cause issues when the seller had to transfer the items onto a truck or another kind of transportation that the buyer had hired rather than immediately onto an international carrier. Banks commonly demand that the seller provide a bill of lading with an onboard notation to be paid, even if the seller and buyer agree to use a letter of credit as the payment method for this transaction.

Typically, an international carrier won’t give such a bill of lading to a seller who didn’t deliver the items to them personally. While keeping up with the new Incoterms 2020 regulations, parties may agree in the sales contract that the buyer should direct its carrier to submit a bill of lading to the seller that includes the onboard note.

• CIP (Carriage and Insurance Paid To):

Risk passes to the buyer once the seller has cleared the items for export and delivered them to the carrier or another person specified by the seller at a specified shipment location. The costs of delivering the items to the specified location and obtaining Insurance are the seller’s responsibility.

Under the Incoterms 2020 regulations for CIP, the amount of Insurance that the seller must purchase has increased. The seller must buy more insurance coverage than the previous Incoterms 2010 CIP requirement. It must be at least 110% of the total value of the products. Moreover, it also includes the transportation costs, as specified in Clause A of the Institute Cargo Clauses.

• CPT (Carriage Paid To):

The seller clears the products for export and delivers them to the carrier or another person specified by the seller at a designated shipment location. The seller is responsible for the international transportation charges linked to delivering products to the selected foreign location.

When products are delivered to an international carrier, the risk is transferred from the seller to the buyer. It means the buyer accepts all risks associated with loading the items onto the carrier and with their international transportation.

• DAP (Delivered at Place):

The seller certifies the goods for export and accepts all risks and expenses related to delivering the products to the specified overseas destination, not unloaded. DAP indicates that the buyer pays all costs and risks associated with unloading the cargo, navigating customs, and bringing the products into the specified destination country.

The DAP offers both parties a great deal of flexibility in that aspect. Under this term, the named place may be a port, the buyer’s location, or any other location which is mutually agreed upon by both parties.

• DPU (Delivered at Place Unloaded):

Delivered at Terminal (DAT) was previously now has a name. And, that name is Delivered at Place Unloaded (DPU). Because the buyer or seller may prefer that the goods be delivered somewhere other than a terminal, this term is frequently used to describe consolidated containers with several receivers.

The main difference between DPU and DAP is that the seller is responsible for unloading the goods. Like with DAP, the seller clears the products for export. He takes all risks and expenses related to the delivery of the products to the indicated location, which may be a port or another designated area in the overseas destination. From this point, the buyer is in charge of all expenses and risks.  That includes clearing the products for importation into the stated destination country.

• DDP (Delivered Duty Paid):

DDP Incoterms 2020 states that the seller bears all responsibility and expense for delivering the goods to the specified destination so that they are ready for unloading and cleared for import.

DDP is a risky term for the seller because they may not completely understand the import clearance processes in the importing country. Or know where to find a qualified local customs broker. The seller must also trade in a foreign currency, which means they are in charge of currency exchange risks. Additionally, not all nations allow non-resident importers. Therefore, the seller must determine how to appoint an importer of record.

2) The following Incoterms are exclusively valid for sea and inland waterway transport

• FAS (Free Alongside Ship):

The seller certifies the goods are positioned alongside the ship at the designated shipping port for export and delivers them. The buyer undertakes all future costs and risks linked with the goods. No one uses this phrase except for the goods that are hard to load.

• FOB (Free on Board):

At the destination port of shipping, the seller delivers the goods after clearing them for export and placing them on board the vessel. All costs and risks associated with the goods go to the buyer at this point. This term is likewise used, with the possible exception of American businesses that might do. This is because they mistake it for the domestic term FOB.

Read more about FOB, by going towards the link mentioned.

• CFR (Cost and Freight):

When the seller clears the goods for export they get onto the ship. The seller pays the cost of freight to the stated port of destination. The buyer is responsible for the risks associated with the products after the items are sent to the ship at the port of export.

The buyer only accepts risk once the goods are loaded into the vessel, unlike the Incoterm CPT, which can only be used for sea and inland waterway transport.

• CIF (Cost, Insurance, and Freight):

The seller clears the products for export. And, delivers them after they are done loading on the ship at the port of shipment. The seller pays the freight cost and Insurance to the specified destination port. Clause C of the Institute Cargo Clauses requires the seller to purchase the least amount of Insurance. This requirement has not changed since shipping Incoterms 2010.

The expense of clearing the products for importation and unloading them at the specified port is entirely the buyer’s responsibility. After the products are loaded on the ship at the port of transportation, the risk is transferred from the seller to the customer.

Chapter 8: Frequently Asked Questions about Shipping Incoterms

• What are Incoterms in shipping?

International Commercial Trade Terms, or Incoterms for abbreviation, are sales terms that purchasers and sellers use in international trade. They specify who is in charge of the duties, expenses, and risks related to transferring the products to the buyer.

• What is the difference between DDP and DAP?

In DPU, the seller is in charge of delivering goods to the final destination. They are also responsible for paying import duties, taxes, and customs clearance. While in DAP, the seller is responsible for delivering the cargo to the final, specified location. The buyer is responsible for unloading the shipment from the truck after the cargo delivery. The buyer also pays import duty, taxes, and customs clearance.

• What is the difference between EXW and FOB?

In EXW, the seller is in charge of packaging the items and making them accessible. In FOB, the customer covers the cost of shipping products to their destination and import fees

• What is needed for CIF and CIP Insurance?

CIP stands for “Carrying and Insuring Paid To,”. It needs an insurance policy that covers at least the Institute Cargo Clause(A).

CIF stands for Cost, Insurance, and Freight. It requires an insurance policy covering at least the Institute Cargo Clause (C).

Conclusion

Yes, shipping incoterms sound confusing, but understanding the concept and implementing the right incoterms for your business is crucial. It can make the whole process easy and hassle-free. As they clearly define the responsibilities of both parties. Incoterms provide straightforward pricing, Insurance, and ownership guidelines for each party. Because language difficulties and cultural differences are widespread in international trade, these terms help to simplify the tasks. Plus, helps in communicating a large portion of the process of transferring products.

No one should use Incoterms for selling goods. Also, no one recommends it for sales of services. One must also be careful not to include conditions and terms that the Incoterms do not define. Suppose one party changes the standard Incoterms used by the seller or buyer. In that case, one should be aware of changes that will affect costs, such as Insurance. As a result, international trading partners must carefully select and negotiate the appropriate Incoterm. As previously said, Incoterms provide a platform for parties to explain their roles by applying internationally accepted contractual standards. And, reducing the likelihood of cross-cultural misunderstandings, contractual ambiguity, and disagreements.