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INCOTERMS, COMMERCIAL TERMS IN INTERNATIONAL TRADE
INCOTERMS, COMMERCIAL TERMS IN INTERNATIONAL TRADE
If you ship goods domestically, you may wonder why you need to understand Incoterms.
Well, actually the vast majority of companies in the United States use the shipping terms identified under the U.S. Uniform Commercial Code (UCC) when shipping domestically, these shipping terms aren’t appropriate to use when exporting.
First of all, let’s take a look at their function!
The principal function of Incoterms is to define with accuracy several important aspects of a transaction. Such as the place of delivery of the goods by the seller, who contracts and pays for the transport and international insurance. Which documents are processed by each party, who bears the costs of the different sections.
The main advantage of incoterms is the standardized terminology used by all companies doing international business or trade. Specific terms or acronyms provide both carriers and buyers with clear rules, helping to avoid confusion about each party’s responsibilities and cost management.
They were developed by the International Chamber of Commerce to be apply in international commerce. They are used for international trade deals and followed by the freight transport association when good is provided. Incoterms clearly define the tasks, costs, and risk involved in delivering and transportation of goods as well as the risks associated to them.
How Incoterms facilitate international commerce?
They are applied by legal authorities as well by the freight forwarders from all countries, including the European ones where there is trade and transport of goods are intensive. But this does not concern only the leading countries such as Germany. But other countries involved in import and export in Middle East, ASIA and even Europe.
Every international shipment involves multiple steps, costs, changes in ownership, and risks for both importers and exporters. Navigating these variables is a critical part of supply chain management. If it is uncertain which party is contracting transportation or providing insurance, for instance, a shipment could be delayed, damaged, or lost without a clear indication of responsibility.
The buyer and the seller agree to the Incoterm of a shipment in advance, which helps determine the three general objectives outlined below.
Deciding how a shipment will get from point A to point B can seem like a fairly basic task. However, an international shipment can have several legs to its journey, and the Incoterm will determine exactly how far the seller will get the shipment before the buyer assumes responsibility. Any transport after that will be the responsibility of the buyer.
International transportation costs can vary significantly depending on lane and mode. The Incoterm on a shipment will not only determine who arranges the transportation but also who is responsible for payment and how it is reflected in the overall transaction. Transportation fees are included in the invoice value of the goods, and can often be deducted for duty and tax benefits.
With many legs to a journey come many points of risk. If a shipment is lost or damaged along the route, it is critical to understand which party bears the risk. The agreed-upon Incoterm will do just that, making the process to a resolution much more streamlined.
What are their impacts on international trade finance?
A universally recognized set of rules that guide buyers and sellers, Incoterms ensure a mutual understanding and avoid mistakes when formulating and fulfilling a contract for the shipment of goods.
Incoterms 2020 consists of 11 terms which are grouped under four separate categories based on the first letter of each term:
Departure (E) e.g. EXW (Ex Works)
Main Carriage Unpaid (F) e.g. FOB (Free on Board)
Main Carriage Paid (C) e.g. CIP (Carriage and Insurance Paid To)
Arrival (D) e.g. DDP (Delivered Duty Paid)
Which Costs should be considered when selecting the right Incoterms?
Changing the Incoterm of an international trade contract should not be taken lightly and need to be the subject of detailed discussion between the buyer, shipper and financial intermediaries.
There are many implications for shipment arrangements, customs clearance, import and export tax liability, local transportation and insurance of goods, as well as inevitably for product pricing.
When taking responsibility for shipping, it is necessary to ensure that all documents are in order to meet customs clearance requirements. Including shippers export declaration, Certificate of Origin, bill of lading or airway bill, purchase order, invoice, packing list, manifests (including details of the cargo, the shipper, consignee, weight, measurement and packing list), export and import licenses (if required). Also as well as any other specific documentation as specified by the buyer, or as required by financial institutions or L/C terms or as per importing country regulations. The arrangement of physical inspection of goods is also necessary to complete this process.
In addition to document preparation and submission, payment of relevant taxes is essential, including customs tariffs, VAT (where applicable), with Tax free zones also taken into account.
Shipping duties also require co-ordination of physical transportation, both locally taking delivery of cargo from the factory and from customs after clearance along with documents as well as international cargo shipment.
How Incoterms affect trade finance opportunities?
Familiarity with Incotermsoften means thatbuyers and sellers take the easy option by following standard industry practice or simply sticking with the terms used in a previous sales agreement with the same customer.
In fact, there are some good reasons why SME manufacturers should carefully consider their choice of Incoterms for upcoming contracts.
One of the key benefits to selecting specific Incoterms is the opportunity to obtain more favorable trade finance.
Invoice discounting is an increasingly popular form of trade finance that involves funding an invoice which is a tradable asset with a tangible value so that the manufacturer can obtain working capital to cover the production and shipping of goods that will only be paid for by the customer some 30-90 days later.
However, an invoice can only be financed after the point at which transfer of risk for the goods takes place between the seller and the buyer. So if a seller wants to maximize the length of funding, it is important to select Incoterms that brings forward the transfer of ownership to the buyer as early as possible.
For example, this might mean considering FCA (Free Carrier) or FOB (Free On Board) rather than DPU (Delivered At Place Unloaded), DAP (Delivered At Place) or DDP (Delivered Duty Paid).