Understanding Incoterms and How to Alleviate Shipping Risks

Have you been shipping products blindly? Shipping without knowing how Incoterms affect your freight creates a risk that could cost you anywhere from a few thousand dollars to completely bankrupting your business.

Incoterms, also known as International Commercial Terms, are the terms of trade for the sale of goods, either domestically or internationally. They are the rules of shipment, determined when a purchase order is cut, and can cover everything from liability to duty responsibility.

Without the proper knowledge of what these Incoterms cover and how they can affect your shipments, you are opening yourself up for the potential of a high-cost to move your goods.

Why Is it Important to Understand Incoterms?

Incoterms are laid out by the International Chamber of Commerce and determine responsibility in the case of a shipping dispute. It is important to remember that these terms are not contracts but rather verbiage that can be used within contracts to protect your bottom line.

It is vitally important to understand Incoterms and to use them correctly because otherwise, you could be opening yourself up to unforeseen costs and liability.

Incoterms are also a tool for negotiation, meaning you won’t get the best deal possible if you don’t know what you are negotiating for or against. For example, a Delivered Duty Paid (DDP) term indicates that the person selling the goods will absorb all of the transportation costs, including duties when they deliver them to the customer.

For this reason, as a buyer, it is important to pay close attention to Incoterms when negotiating a contract. Either through simple ignorance or in an effort to close a sale, avoid overlooking an Incoterm that may place you responsible for hefty costs related to your transport.

The understanding of Incoterms is important knowledge for everybody at your organization to have. Your billing can be greatly affected if the individual negotiating the contract sets the Incoterms, but your sales and purchasing departments are unaware of their impact and veer from them.

Standard Incoterms 2019 & 2020

Currently, there are a total of 11 Incoterms. However, these will be amended by the upcoming Incoterms 2020 update. Keep in mind, not all of the terms will apply to your unique situation. Every business is different and, as such, so are their shipping needs. By getting to know Incoterms, you will have a great tool to add to your knowledge tool box.

The first seven Incoterms deal with shipments by air, road, rail, sea, or multi-modal. The last four are  for shipments by sea and inland water only.

2019 Incoterms: 

• Ex Works (EXW) – The seller is only responsible for the freight until it is loaded on the truck, ocean carriers, etc. The buyer assumes responsibility from that point forward.
• FCA (Free Carrier) – This is the most popular Incoterm, carried out by 40% of international trade operations. It allows you to note the delivery of goods, whether that be a port, an airport, a container freight station, or the seller’s address.
• CPT (Carriage Paid To) – This implicates the seller to pay the cost of carriage up to the destination agreed upon by both parties.
• CIP (Carriage and Insurance Paid To) – CIP is an Incoterm designed for maintaining control over a shipment. On top of CPT, this clause also requires the seller to insure a shipment on behalf of the buyer.
• DAT (Delivered at Terminal) – DAT is another common Incoterm for a buyer seeking full control over their shipment. In this case, the seller is responsible for all risks associated with the shipment until its arrival at a predetermined place of destination.
• DAP (Delivered at Place) – This allows the buyer to determine the place of delivery.
• DDP (Delivery Duty Paid) – DDP places all responsibility for the cost of the shipment—duty included—on the seller. In this case, the seller will likely receive more than one invoice, so keep an eye out for that.
• FAS (Free Alongside Ship) – This Incoterm implies that the seller has delivered the shipment once it has been placed alongside the pre-established vessel. In the case of damage or loss, insurance liability is sometimes difficult to determine. This Incoterm helps to establish responsibility.
• FOB (Free on Board) – FOB implicates the seller in the responsibility of delivering the goods on board the vessel of the buyer’s choosing at their named port. The responsibility for loss or damage to the goods is transferred from the seller to the buyer once the goods are on board the vessel.
• CFR (Cost and Freight) – This places the seller responsible for paying all costs and freight for the shipment up to the named port of destination.
• CIF (Cost, Insurance, and Freight) – CIF places the seller responsible for CFR as well as minimum insurance coverage on the freight up to the port of destination.

Related Content: IMO 2020: What Shippers Need to Know

Being aware of different Incoterms and knowing how they may affect your business is an integral part of the shipping process. Knowing how to use them is also essential. For example, if you include FOB in your terms, be sure to name a location. Leaving that vital piece of information open to interpretation can wreak havoc for both parties involved.

Perform your due diligence and be sure to specify your Incoterms when you reach out to a forwarder for a shipping quote. Otherwise, you may not be comparing apples to apples. If you leave your Incoterms open-ended, you may receive vastly different quotes or nasty surprises when invoicing arrives.

Typically, Customs brokers or freight forwarders ask about Incoterms when quoting freight. It is your responsibility to be aware of them and identify which ones apply to you as early on in the process as possible. These terms tend to drastically affect your shipping. When your business relies on you to make responsible, well-informed decisions, you don’t want to leave anything up to chance.