Incoterms is an abbreviation for International Commercial Terms, which are a set of predefined commercial terms drafted by the International Chambers of Commerce (ICC). First published in 1936, Incoterms rules provide internationally accepted definitions and rules of interpretation for most common commercial terms.
Incoterms are primarily a set of three-letter codes which define trade terms related to responsibilities of businesses involved in a shipping or sale relationship. Simply put, they exist as a guide to ‘who does what’ in a variety of scenarios such as in the case of fright and insurance under the terms of a shipping contract. They aim to help traders avoid costly misunderstandings by identifying the tasks, costs and risks involved with the delivery of goods from sellers to buyers. Incoterms are recognised by UNCITRAL as the global standard for the interpretation of the most common terms in foreign trade.
A full list of Incoterms can be found here.
Why use Incoterms in international trade?
Despite other clauses for global trade existing around the world, Incoterms are global in their reach. They do not include trade terms codified for national purposes such as the ‘less than truckload shipping’ (LTL) rule used within the United States. Instead, Incoterms are universal, providing clarity and predictability to businesses all across the world.
When a business decides to enter international trade, whether that is selling a product oversees or importing finished goods and raw materials, it will be faced with a number of barriers. The logistics of physically moving goods can sometimes call into question the decisions that have made to operate in overseas markets that have been made at board level. Once a trade has been agreed, the responsibilities and roles of the various parties must be agreed upon and clear to all.
The majority of the work falls to the exporter, as they must produce the goods to be shipped, deal with a freight forwarder, assign a shipment date and vessel with the customer and comply with the terms of both the sales and shipping contract. The importer will have to apply for a letter of credit from their bank, transfer the terms of the contract onto his application, get in touch with a native freight forwarder preferably in the port where the goods have been agreed to arrive and possibly arrange insurance if not set out in the terms of the shipping contract.
Types of Incoterms
The above shows the full list of Incoterms and the transfer of risk, as of January 2020. The three most popular Incoterms are; CIF (Cost Insurance and Freight) Incoterms, FOB (Free on Board) Incoterms and CFR (Cost and Freight) Incoterms.
- CIF Incoterms – This is a wide-ranging package where the seller in solely responsible for the foods until they arrive at the destination port.
- FOB Incoterms – These terms set out that the exporter pays all costs up the and including the loading of goods onto the vessel for shipment. The buyer is then responsible for the cost of shipment, insurance and all costs in the country where the shipment is being sent.
- CFR Incoterms – If this Incoterm is used in the sales contract, the seller is responsible for paying all carriage costs up to and including arrival at the port of import. Importantly, the buyer remains in charge for the insurance of all goods.