FLASH SALE! - "FINANCIAL MODELING COURSE BUNDLE AT 60% OFF" Enroll Now

Incoterms

Updated on April 4, 2024
Article byPrakhar Gajendrakar
Reviewed byDheeraj Vaidya, CFA, FRM

Incoterms Meaning

Incoterms stands for international commercial terms. It is a universal terminology used by importers and exporters. International trade contracts and transactions comply with International commercial terms. All concerned parties must understand the terms well enough to comprehend costs, responsibilities, risks, and logistics.

Incoterms

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Incoterms (wallstreetmojo.com)

International Chamber of Commerce (ICC) publishes and authorizes international commercial terms. Different abbreviations are used depending on the mutually agreed-upon conditions and clauses between an importer and an exporter.

Key Takeaways

  • The incoterms are authorized commercial terms used in international trade and logistics.
  • The International Chamber of Commerce legalizes these terms. The ICC headquarters is situated in Paris, France. In 2022, more than 100 countries will comply with ICC standards.
  • There are 11 types of incoterms, FCA, FAB, FOB, EXW, CIPT CIP, CFR, CIF, DAP, DDT, and PDF.
  • International commercial terms are also mentioned on shipping documents.

Incoterms Explained

Incoterms are regulations that are to be followed in international trade and logistics. When commercial terms are standardized internationally, import-export operations become faster and hassle-free. International commercial terms are governed by the International Chamber of Commerce (ICC).

ICC was established in 1919 to facilitate international trade. Initially, ICC had only 13 member nations The rest of the world had its own import-export rules. The disparity in international trade regulation created chaos.

In 1928, International commercial term charts improved, and ICC expanded to 30 member nations. The most recent International commercial terms amendment took place in September 2019. In 2022, more than 100 countries will comply with ICC standards.

The updated International commercial terms table is accepted by legal authorities worldwide and thus plays a pivotal role in international trade and transactions. It creates transparency between the buyer and seller. International commercial terms dictate regulations about costs, risks, location, fees, and tasks. International commercial terms are also mentioned on shipping documents.

Since 2020, the exploitation of international trade has been witnessed; International commercial terms are being misused. Exporters are not using the correct abbreviation. For example, FOB (Free On Board) refers to sellers moving goods independently. But exporters label it as CIP (Carriage and Insurance Paid To); CIP only requires sellers to pay for the transport, and a third party carries out the actual transportation.

It is becoming a severe issue. As a result, countries are trying to make the necessary changes to resolve the complications—better access to documentation, regular training on updated rules, and promotion.

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

Types of Incoterms

Incoterms are further divided into four types. The subtypes are further divided; all in all, there are 11 International commercial terms:

#1 – Category E (Departure)

  • EXW (Ex Works)

#2 – Category F (Main consignment unpaid)

  • FCA (Free Carrier)
  • FAS (Free Alongside Ship)
  • FOB (Free on Board)

#3 – Category C (The main consignment paid)

  • CPT (Carriage paid to)
  • CIP (Carriage and Insurance paid to)
  • CFR (Cost and Freight)
  • CIF (Cost, Insurance, and Freight)

#4 – Category D (Arrival)

Example

Let us look at an incoterms example to understand the procedure better.

Let us assume that Gary enters a DDP deal with Jeremy. Jeremy is an exporter who operates from London ports. Gary is an importer who operates from US shores (New York).

In 2022, Gary purchases a battery consignment from Jeremy. However, according to DDP International commercial terms, Jeremy has to pay for the transportation and storage costs (London port to New York port). Moreover, if the batteries get damaged, Jeremy has to bear the loss.

Once the battery consignment arrives in the New York port, Gary (buyer) will pay for the unloading of the batteries.  Meanwhile, Jeremy covers costs like local taxes, tariffs, and customs duties.

According to 2022 incoterms, if the contract mentions a terminal destination, Jeremy (seller) is free from additional freight expenses. But if the agreement mentions Gary’s address, Jeremy must pay freight expenses.

Under DDP terms, Jeremy (seller) knows all the costs and risks included. In turn, sellers charge extra for the risks. As a result, Gary bears fewer risks but ends up paying more.

Advantages And Disadvantages

The advantages and disadvantages of incoterms are as follows:

  • International commercial terms offer uniformity in communication between two parties.
  • It is accepted worldwide. International commercial terms encourage transparency.
  • International commercial terms save time and reduce red tape. 
  • It facilitates the control of the supply chain.
  • International commercial terms streamline the entire trading and shipping process.

Now let us look at the disadvantages:

  • First, companies need help to keep pace with all the modifications.
  • Buyers and sellers can have different preferences—one might prefer a CIF, another a FOB. But, in the end, one of them has to concede. Practically, this isn’t easy because there are too many deal structures.
  • Companies misuse International commercial terms. For example, they use one abbreviation for shipping documents and another for purchase invoices. This way, firms attempt cost-cutting malpractices.

Incoterms vs Payment Terms

Let us look at incoterms vs payment terms comparison to distinguish between the two.

  • International commercial terms are used for cross-border and overseas trade. In contrast, payment terms are used for domestic trades.
  • International commercial terms are agreed upon with the freight carrier, but payment terms are discussed with the seller.
  • International commercial terms cite which party is responsible for loading, transporting, and unloading. In contrast, payment terms predominantly focus on the payment details—which party pays for which process.

Frequently Asked Questions (FAQs)

1. Why are incoterms used?

International commercial terms are used for the following purposes:
– To facilitate a common language between importers and exporters
– To facilitate smooth import-export.
– To facilitate tracking of consignments.

2. What do incoterms in shipping mean?

International commercial terms are a collection of commercial trade rules introduced by the ICC. International sale contracts are mandated to comply with international commercial terms. They are not mandatory for shipping but must be followed and mentioned in the trade contract between two parties.

3. Why are incoterms important?

International commercial terms are necessary because of the following reasons:
– These terms are globally understood and accepted.
– They are used as shorthand between trade parties.
– Traders explicitly use them to avoid confusion and delivery status errors.

This article has been a guide to Incoterms & its meaning. Here, we explain its types, example, advantages, disadvantages and comparison with payment terms. You can learn more about it from the following articles –

Reader Interactions

Comments

  1. BAIMBA SESAY says

    I WOULD LIKE TO BE A MEMBER,OF THESE LECTURES NOTE.

Leave a Reply

Your email address will not be published. Required fields are marked *