Companies engaged in international trade are well acquainted with Incoterms, the rules that define the respective obligations of sellers and buyers in commercial transactions. These standards are essential for harmonizing practices, especially since interpretations of sales or purchase conditions often vary from one country to another. Let’s dive into the details of these universal trade terms.
What are Incoterms?
Incoterms (International Commercial Terms) were established by the International Chamber of Commerce (ICC) in 1936 to regulate international transactions. They define the allocation of responsibilities related to transport, insurance, customs formalities, and the transfer of risks between buyers and sellers. These universally recognized terms apply exclusively to the exchange of physical goods.
Incoterms help answer key questions:
- Who is responsible for shipping and insurance costs?
- Who handles customs formalities or import costs?
- When and how is the transfer of risk executed?
The seller is generally responsible for defining and indicating the applicable Incoterm on commercial documents, particularly on the invoice.
Why adopt Incoterms?
Incoterms offer numerous advantages for businesses engaged in international trade:
- Clarification of responsibilities: They define each party’s obligations, reducing misunderstandings.
- Reduction of disputes: These standardized terms minimize conflicts due to cultural or linguistic differences.
- Cost optimization: By specifying responsibilities, they facilitate logistics cost management.
- Legal compliance: Their adoption ensures adherence to international trade standards.
- Simplified negotiations: Providing a clear and common framework, they accelerate contractual discussions.
The 11 Incoterms in detail
Incoterms are divided into two main categories based on the mode of transport used:
Incoterms applicable to all modes of transport: EXW, FCA, CPT, CIP, DAP, DPU, DDP
Incoterms specific to maritime and inland waterway transport: FAS, FOB, CFR, CIF
Incoterms applicable to all modes of transport
- EXW (Ex Works): The seller makes the goods available at their premises on a set date. The buyer assumes full responsibility, including transport arrangements, export and import formalities, and all associated costs and taxes. The buyer also assumes all risks from the moment the goods are made available.
- FCA (Free Carrier): The seller delivers the goods to a carrier designated by the buyer, covering export formalities and costs. Once the carrier takes possession, the buyer bears all costs and risks.
- CPT (Carriage Paid To): The seller pays for transport to the agreed destination. However, risks transfer to the buyer once the goods are handed over to the first carrier.
- CIP (Carriage and Insurance Paid To): Similar to CPT, but the seller must also provide insurance covering loss or damage during transit.
- DAP (Delivered At Place): The seller covers transport costs and risks until the agreed delivery location but does not handle import customs formalities.
- DPU (Delivered at Place Unloaded): The seller manages transport and unloading at the agreed destination. This is the only Incoterm requiring the seller to unload the goods. Import customs formalities and related costs remain the buyer’s responsibility.
- DDP (Delivered Duty Paid): The seller assumes all costs and formalities, including customs duties, until final delivery at the agreed location.
Incoterms specific to maritime and inland waterway transport
- FAS (Free Alongside Ship): The seller transports the goods to the port of shipment and handles export formalities. The buyer takes over costs and risks once the goods are placed alongside the vessel, ready for loading.
- FOB (Free On Board): The seller also loads the goods onto the vessel. After loading, costs and risks transfer to the buyer.
- CFR (Cost and Freight): The seller pays for transport to the destination port but does not include unloading costs. The transfer of risks occurs once the goods are loaded onto the ship.
- CIF (Cost, Insurance and Freight): Similar to CFR, but the seller also provides insurance covering at least 110% of the goods’ value.
EXW: The ideal Incoterm for sellers!
If you are exporting goods and your negotiations allow it, consider using the EXW (Ex Works) Incoterm. This option is particularly advantageous for sellers, as it limits responsibilities to preparing the goods at their premises, freeing them from further logistical obligations.
Incoterms evolve to adapt to global trade
International trade regulations evolve to respond to market transformations. After Incoterms 2010, a new version was published in 2020 and remains the current standard. However, Incoterms 2010 can still be used, provided they are explicitly stated in negotiations to avoid misunderstandings.
Among the changes introduced in 2020:
- The term DPU (Delivered at Place Unloaded) replaced the former DAT (Delivered at Terminal), highlighting the growing importance of deliveries to various locations such as warehouses or factories, and not just terminals.
- The term FCA (Free Carrier) was adapted to include a letter of credit option, facilitating transactions for sellers.
Incoterms 2020 emphasize greater security for goods and provide more flexibility to meet businesses' varied needs, especially concerning insurance and customs formalities.
Understanding the distinction between departure and arrival
To optimize transactions, it is crucial to distinguish Incoterms based on their management of risks and responsibilities during transport:
Departure-based sales: The goods travel at the buyer’s risk during the main transport. This category includes eight Incoterms:
Multimodal Incoterms: EXW, FCA, CPT, CIP
Maritime Incoterms: FAS, FOB, CFR, CIF
Arrival-based sales: In this case, the seller assumes the risks and costs related to the main transport. Three Incoterms are concerned: DAP, DPU, DDP.
Essential tools for secure trade
Incoterms play a key role in facilitating international trade, particularly in the face of the complexity and speed of modern trade flows. By clarifying the respective responsibilities of the parties, they minimize misunderstandings and strengthen mutual trust, contributing to solid and lasting business relationships.
However, their use alone does not guarantee a successful transaction. To protect your interests and margins, securing payment is imperative. Disputes with foreign companies can be complex, with uncertain outcomes.
To avoid such inconveniences:
Take out trade credit insurance to cover unpaid invoices.
Request a financial health analysis of your business partner before concluding an agreement.
Finally, be sure to integrate the chosen Incoterm into your general terms and conditions to clarify your contractual obligations.
