The Importance Of Incoterms In International Trade

If you're shipping internationally, or have international clients, Incoterms can be a valuable resource. Incoterms is a name given to the specific terms used in international commercial transactions. They are standardized and help with the clarity of the language involved when discussing an importation or exportation of a product. Learning what these terms are, how they work and why they're important, will be quite beneficial if you're planning to ship internationally.

Incoterms is the short version for the “International Commercial Terms” used in international shipping, and early on in the sales process. These are internationally recognized rules which outline responsibilities or obligations of buyer and seller. The rules outline the conditions to which seller and buyer agree to, such as who pays for what and who is responsible for which aspect of the goods transport and sale.

The terms help define the responsibilities each party, either buyer or seller, may have, such as customs clearance, arrangement of transport, risk, insurance, and costs associated with the shipment. They specify when costs and risks are passed on from seller to buyer, but not the legal ownership portion however. While the rules are helpful in the context of sale and are globally recognized, they are not law or compulsory. They are not a contract establishing the terms of sale such as transfer of ownership, and they do not apply to the contract with the carrier. They do, however, become legally binding once they are included in a sales contract.

Why Are Incoterms Used?

The reasons Incoterms can be beneficial is that they provide instruction to the parties involved, including carriers, freight forwarders and even brokers. They help outline the costs, obligations and assumption of risk on the shipment.  In the case of cargo damage or potential loss, the risks are assumed by the party outlined in the terms. The responsibility for the shipment is also passed onto the relevant parties using these terms.  They are a reference point, where the rules help clarify who is responsible for goods insurance, transport costs and the assumption of risk when the goods go from seller to the buyer.

In international shipping, there are many costs and liabilities involved, and unless the contracts and other documents stipulate responsibility, there can be a lot of confusion as to who is responsible for what. A buyer who chooses to purchase goods from another country has to consider the other risks and costs associated with the purchase. Some factors to consider in these international transactions include:

• Who is arranging the transport of the goods?
• Who is submitting documents for customs clearance and paying the fees?
• Who is taking care of the loading of goods?
• Is there cargo insurance and who is paying for it?

Transporting goods internationally comes with risks and added costs, so using Incoterms to help outline which party is taking on the responsibility is important. Using these terms, the buyer and seller can both understand their role and responsibilities, and avoid potential disputes down the line.

Where Are Incoterms Used?

There are several documents you may see Incoterms used on. They can be included on a proforma invoice, sales contract, commercial invoice or a purchase order. They are especially beneficial on a commercial invoice.  Buyers will want to look into using Incoterms before negotiating a sales contract, so that they are not taken advantage of later in the process.

Which Incoterms Apply In 2023?

Incoterms originated in 1936 and are usually revised and updated every 10 years, by the ICC. The last known revision occurred in 2020, which means that these rules would apply today. Some changes have been made to the 2020 terms, as the rules are being constantly revised to help simplify matters and reduce complication risks.  Some of the latest revisions to remember include:

• DAT is changed to DPU - (Delivered At Terminal) is now “Delivered at Place Unloaded”, as delivery of the goods can now occur somewhere other than the terminal.
• CIP is amended to require seller to purchase 110% of the value of goods in insurance coverage.
• More specifications on security requirement responsibilities – outlining who is responsible.
• Allowance for seller to use their own transport for the goods.

There are a total of 11 Incoterms which are 3 letters each. They are most easily categorized either into groups E, F, C or D or as mode of transport (any mode, or sea/water). 

Group E:

• EXW: Ex Works, where the buyer takes on the responsibilities.

Group C:

Seller will be responsible for delivery, and they pay for transport. However, once the goods are loaded for transport, the buyer would assume the risks.

• CIF:  Cost, Insurance and Freight, seller pays for insurance coverage and the freight contract.
• CFR: Cost and Freight, used in water transport, and the seller takes care of the freight contract but then buyer assumes responsibility once the goods are on board.
• CIP: Carriage and Insurance Paid To, the freight and insurance is paid for by seller.
• CPT: Carriage Paid To, the seller would arrange transport only, but they do not cover insurance.

Group F:

The seller in this group would be responsible for delivery in accordance to the pre-arranged shipping method. But the shipping method has been paid for by the buyer. The buyer also has additional costs as well as assuming the risks.

• FAS: Free Alongside Ship, seller delivers goods to agreed port, usually bulky goods and places them beside the chosen vessel. The buyer arranges the vessel and assumes cost and risks of the freight contract.
• FOB: Free On Board, seller delivers the goods onto the vessel which was appointed by the buyer, who then assumes responsibility once the goods are loaded onto the vessel.
• FCA: Free Carrier, seller delivers the goods to the arranged location, but buy takes on risks of freight contract and costs.

Group D:

The responsibility in this group would mainly fall on the seller, but once the goods arrive at the designated location then the buyer can assume responsibility of a few matters.

• DAP: Delivered At Place, seller responsible for any costs up to the destination of goods, and goods are delivered ready to unload. Customs clearance and import fees fall on the buyer.
• DAT has changed to DPU: Delivered At Terminal is now Delivered at Place Unloaded, seller will be responsible for all costs until the cargo is delivered to the location agreed upon. This is the only term that will require the seller to unload goods at a specific destination.
• DDP: Delivered Duty Paid, seller would be responsible for most of the costs and responsibilities of the goods.

It is also important to understand the Incoterms can be categorized based on the mode of transport used, and certain terms apply only to a certain mode of transport. The two would be divided as such: 

• Sea and waterway transport terms include: CFR, FAS, FOB and CIF
• Any mode of transport will include terms: CPT, CIP, DPU, DAP, DDP, FCA and EXW

Incoterms are designed to help make transactions between parties easier by giving them a basic understanding of each other's legal rights and obligations. It’s best to look at them as a set of rules used by traders to classify the way that shipping and handling fees are calculated for an international shipment. Knowing how these rules work will help you figure out what your costs should be when sending goods overseas. Understanding Incoterms will help you make informed decisions about your international trade, and protect your business.