Incoterms Explained: Everything You Need to Know

Incoterms - the essential terms of trade

Incoterms are international commercial terms that establish the allocation of risk, cost, and responsibility for goods during transport between a buyer and seller.

Incoterms are beneficial because they lessen the time you spend haggling over who is responsible for what during transit. They vary depending on what the buyer and seller need – for example if you want to take control of your cargo from the seller’s warehouse or at the final port of destination.

When did Incoterms come into existence?

The International Chamber of Commerce established the Incoterms in 1936 to reconcile discrepancies in international trade agreements. Incoterms are international delivery terms that work as a contract between the seller and buyer. They lay out all duties, costs, and risks involved in the worldwide transaction of goods and are thus crucial trading conditions.

When are Incoterms used?

Incoterms are vital for global trade as they determine the most important contractual terms and obligations, such as the import, export, and transit of goods.

It governs aspects of the transport contract including, but not limited to, matters such as insurance, transfer of risk, place of delivery, and information obligations.

Questions that Incoterms answer:

• Who is responsible for the cost of shipping?
• Who is responsible for the cost of insurance?
• Who will have to pay the import fees?
• Who is responsible for customs clearance?
• Who is responsible for transporting goods and where will it end up?
• Who is responsible for the goods, and until when are they responsible?

Incoterms are standardized international trade terms that aim to prevent different interpretations of transport agreements by parties from different countries. The first time this was noted was in 1936, and since then, the rules have been updated seven times - every decade. The most recent set of rules is Incoterms 2020.

How to use Incoterms?

If you are selling products, be sure to include your chosen Incoterms and HS codes on your commercial invoice for shipping outside of the EU.

Better yet, include them in your terms and conditions. Informing customers that they are responsible for customs charges (or any other aspects) will save you future headaches. Most consumers won't understand what each Incoterm means. Make sure your customers thoroughly understand the Incoterm(s) you select by explaining each condition in detail.

Incoterms must be chosen carefully, as different carriers may not support every term. To make sure that you can use your desired carrier, always check with them first.

How do the Incoterms Function?

Incoterms are essential for the international shipment of goods. Here is a summary of their various functions.

Main functions:

• Allocation of Costs: Who will pay for what expenses?
• How are responsibilities and risks divided between the two contracting parties? Who is responsible for what, and when?

Other functions:

• Documentation for Goods: Who is responsible for purchasing the necessary documents?
• Customs: Who is responsible for customs clearance: the contracting party or ourselves?
• Documentation for Transportation: Which partner should purchase the transportation documents?
• Shipping insurance: Which partner is responsible for insuring the goods during which part of the transport?
• Necessary Information: When and about what topics should each contract partner update the other?
• Inspection of Goods: Who is completing the goods inspection?
• Packaging of Goods: Who is responsible for deciding the type and packaging method of products?

There are 11 (eleven) different Incoterms in total. The key distinction between these types of International Commercial Terms is when the risk shifts from the seller to the buyer.

So, at what point is the buyer responsible for;

• transport costs?
• shipment risks?
• shipping insurance?

What Incoterms 2020 changes have been made?

The term DAT has been changed to DPU, which stands for Delivered at Place Unloaded. This is because goods can not only be delivered to a terminal or dock, but also at any other point where it is possible to load goods— such as a factory or warehouse.

The new on-board BL (Bill of Lading) option is added to the FCA:

This means that the sales agreement can stipulate that a Bill of Lading must be issued. The Bill of Lading demonstrates that merchandise has been loaded onto the mode of transportation. By going around third parties, the buyer is now telling the carrier to give this "note of board" directly to the seller.

The difference in the level of coverage for CIP and CIF:

CIP requires that the seller have comprehensive transport insurance, while with CIF only minimal coverage is required.

DAP, FCA, DPP, and DPU have their own transport means:

For these, businesses that own their vehicles can transport their own goods.

Understanding The 11 (Eleven) Incoterms

• EXW (Ex Works): Once the seller has given the buyer access to goods at an arranged location, the majority of costs and risks fall on the shoulders of the buyer for shipping.
• FCA (Free Carrier): The seller is obligated to make the merchandise available at their establishment or another arranged location, and they must do so securely. In either case, the seller is also responsible for ensuring that the goods are able to be exported. If the buyer so desires, they can have a carrier with a "Bill of Lading (BL)" note on board to transfer ownership of the goods to the seller.
• CPT (Carriage Paid To): Much like with FCA, the seller is responsible for delivery costs.
• CIP (Carriage Insurance Paid To): The seller is responsible for the same liabilities as with CPT, only in this case the insurance must have high coverage. Parties can agree to limited coverage separately.
• DAP (Delivered At Place): The seller is liable for the cost and any potential accidents that might happen while sending the product to a planned destination. The buyer is in charge as soon as the items have safely arrived and are unloaded at this address.
• DPU (Delivered at Place Unloaded): The party who agrees to provide the goods will pay for the transport and risks associated with delivering them to an agreed-upon destination. The selling party manages customs declarations and unloads the goods at the buyer's specified location. The buyer is responsible for clearing customs and any related rights that fall beyond simply transport from the arrival point.
• DDP (Delivered Duty Paid): The risks and duties of exporting fall on the seller until the goods arrive at their destination, upon which point they become the responsibility of the buyer.
• FAS (Free Alongside Ship): The seller covers the costs and risks until the items are delivered next to the ship. After that, it's up to the buyer to deal with export and import clearance.
• FOB /9Free On Board): All responsibilities for the export fall on the shoulders of the seller until such time as the buyer takes possession of the goods.
• CFR (Cost And Freight): With FOB, the seller pays for the transport of the goods to the port.
• CIF (Cost, Insurance, and Freight): Under CFR terms, the seller covers basic insurance costs while the buyer pays for additional comprehensive protection.

Incoterms Groups

There are four groups into which the Incoterms can be divided to make the biggest differences more transparent:

• Group C: There are four Incoterms where the seller is entirely responsible for the main transport costs-- these terms are CFR, CIP, CPT, and CIF. The party who sold the merchandise is only relieved of responsibility once the product has been given to a third-party carrier. Even then, they are still responsible for any related insurance or costs.
• Group D: The three Incoterms where the seller is responsible for all costs and risks until goods arrive at an agreed destination are DAP, DPP, and DPU.
• Group E: The only "collection" Incoterm is EXW, which means that buyers are responsible for almost all transport costs and risks.
• Group F: The three Incoterms where the seller does not cover the costs and risks of transport are FOB, FAS, and FCA. As soon as goods are handed over to carrier services, the buyer becomes responsible for any cost or damage incurred during main transport.