Incoterms – Meaning, History, Benefits and More

Incoterms (or International Commercial Terms) is a term that one would come across in international trade. Basically, these terms help to make buying and selling easier for both parties in international trade. These rules and standards facilitate international trade by removing the confusion. It is very important to know the terms in the same sense by all the traders internationally. In other words, these terms and definitions thereof bring every transaction at par. Without this, interpretation may differ and then a dispute arises as cost and risks are major issues.

In foreign trade, the buyer and seller use these terms as a standard having the same meaning to avoid any interpretational issues. These terms allow them to understand the technicalities of foreign trade and the importance of each and every term. Moreover, the use of these terms enables parties to understand all the elements of the transactions in a similar manner. These elements include costs, risks, rights, responsibilities, and transportation. However, these terms mostly focus on transportation, as well as the point when the risk gets transferred from the buyer to the seller.

A point to note is that these terms in themselves are not mandatory rules. To give them legality, it is important that both parties incorporate these into their agreement.

History of Incoterms

The International Chamber of Commerce (ICC) creates and publishes these terms. They are also responsible for revising it from time to time depending on the trade needs and dynamism. These terms enjoy the backing of governments, regulatory authorities, as well as practitioners globally. These terms are used in contracts in a 3-letter format.

The first incoterm came out in 1923, and the last set came in 2010. And, the ICC has been regularly updating these terms since then. And, the latest edition of these terms is Incoterms 2020. Currently, there are 11 such terms that the parties can apply to the foreign trade contracts.

In 2010, ICC also classified these 11 terms into two categories. One category covers any mode of transport. And, the second covers sea and inland waterway transport. Following are the two categories:

Group 1 Incoterms: Apply to Any Mode of Transport

These include the following incoterms:

Group 2 Incoterms: Apply to Sea and Inland Waterway Transport

These include the following incoterms:

We will discuss each one of these terms later in this article.

Incoterms

What They Cover?

There are primarily four areas of stages in foreign trade that Incoterms cover. These are:

Delivery stage – it is when the two parties finalize the terms and conditions of the final delivery. Or when the goods exchange hands and the duty of the seller finishes and the responsibility or ownership of the buyer starts. 

Transportation stage – this involves agreement on the transportation costs, such as the sharing of the costs, or if each party will be responsible for up to what leg of transportation.

Documentation and formalities – this stage helps to clear out the responsibilities of both parties with regards to the official formalities. These formalities could be documentations, duty payments, customs and more.

Insurance – it clears out the responsibility of the parties towards insurance. For example,  between buyer or seller who will be responsible for providing insurance during transportation or up to what leg of transportation.

Advantages of Incoterms

Following are the advantages of using these terms:

  • The use of these terms helps in making communications clear between the buyer and seller. This leaves no room from different interpretation between the trading partners. This, in turn, helps to lower risk in foreign trade.
  • Since these terms cover almost all aspects of international trade, they help to answer all buyer and seller queries, like when the delivery will complete, what are the modes of transportation, who will bear the varying costs and more.
  • By putting or incorporting these standard terms in the contract a legal cover can be given to the transactions.

All Incoterms: Abbreviations, Meaning and Explanation

Following are some of the most popular incoterms that buyers and sellers use in international trade:

Ex Works (EXW)

This means the buyer is responsible for collecting the items at the sellers’ location. Also, the buyer bears the transportation costs, as well as the risks in transporting the goods. The sellers’ responsibility is to make available the goods at their location. And thereby all costs and risks are borne by the buyer from the seller’s location to its place. In this, actually, the seller takes no responsibility except delivery at its premises. We can say this is the most favorable term of transactions for the seller.

Free Carrier (FCA) 

This implies that it is the responsibility of the seller to hand over the goods to the first carrier. After this, all risks and costs pass over to the buyer. In other words, this is the next level of operations from Ex-Works where the seller takes the responsibility to transport the goods up to the carrier location. In other words, it becomes the responsibility of the seller to hand over the goods to the first transporter – land or air or water. 

Free Alongside Ship (FAS)

In this, the seller needs to transport the items alongside the ship and at the port that the buyer specifies/named in the contract. In other words, delivery of goods to the shipping company, alongside the ship remains the obligation of the seller. And there onward risk passes to the buyer from the seller. 

Incoterms (any mode)

Free on Board (FOB) 

The seller here needs to go one more step from FAS and needs to ensure loading of the items on board of the ship that the buyer specifies/named in the contract. Risk for seller finishes when the items are on board of the ship.

Cost and Freight (CFR) 

The seller needs to bear all the costs and freight to get the items up to the destination port. The risk, in this case, gets transferred to the other party only when the items are delivered on board the ship. Till that time all arrangements and costs remain the responsibility of the seller, including freight till the destination port.

Cost, Insurance and Freight (CIF) 

This is the same as CFR. The only difference being the seller here is also responsible to buy and pay for the insurance of goods supplied. In other words, in the case of CIF, all costs (including freight and insurance) are borne by the sellers till the destination port. Whereas risk gets transferred once it is delivered/handed over to the shipping company at the named port. 

Carrier and Insurance Paid to (CIP) 

In this situation, the seller pays for the carriage and insurance of the goods till the destination port or some other delivery location as may be named in the contract. Though the cost remains in the seller’s account, however, the risk passes to the other party when the seller hands over the items to the first carrier.

Delivered Duty Paid (DDP) 

Here the responsibility of the seller extends beyond his own country. And he has to pay and manage all the costs and risks till the goods reach the named destination in the buyer’s country. In other words, the seller to ensure delivery of the goods to the destination in the buyer’s country. Buyer’s costs and responsibility start only thereafter. 

Delivered At Terminal (DAT) 

This term, if used in the contract, means the seller is responsible for unloading and placing the goods at the terminal at the port (or at the place of destination) that the buyer specifies. The seller bears all the risk and costs up till unloading the goods at the terminal that the buyer specifies. In other words, the seller has to do all till the goods are unloaded/delivered at the named place.

Incoterms (waterways)

Delivered At Place (DAP) 

This one way is exactly the opposite of Ex-Works, where everything was to be done by the buyer. In DAP the seller takes over all the responsibility to deliver the goods at the buyer’s place. This means handing over goods to the transporter or on his vehicle that agrees to unload or deliver the goods at the buyer’s place. Or we can say handing over the goods to the buyer’s factory/warehouse or any such location. Obviously, all end to end costs and risks remains of the seller till it reaches the buyer.

Final Words

There is no doubt that Incoterms helps to make international trade smooth. It clears the responsibilities of the buyer and seller at all the stages of foreign trade. However, these terms have their own limits. For instance, the parties can not use these terms for creating contractual rights and obligations that do not relate to the deliveries. Also, these terms do not offer a solution in case a party breaches the terms of the contract. In short, these are the terms used only for the movement of goods and not for the entire transaction or trade.

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Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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