A Guide to Shipping Terms and Incoterms
It is important to have an understanding of cost and freight (CFR), cost, insurance and freight (CIF) and Free on board (FOB). There is much talk in the trade world about incoterms and how something is shipped; these terms have their own nuances.
It is important to first note the difference between the shipping terms CFR and CIF. The main variance is that under CIF; the exporter or seller is required to provide a minimum value of marine insurance for the products that are shipped.
Incoterms – What are they?
Following the creation of the International Chamber of Commerce in 1919, the ICC’s first initiative was to facilitate international trade. This led to the introduction of six commonly used terms across 13 countries, that were supposed to provide transparency, trust and clarity in international transactions.
Fast forward to 2010, the global trading world was then introduced to Incoterms 2010 – some of the most popular, required and beneficial terms that businesses around the globe could use to mitigate the risks involved with cross-border trade. These have since been updated, and we now have a revised and updated Incoterms 2020. For more information on the changes made, and more granular detail please see our article on the 2020 set of Incoterms.
The reason for the differences of terms is that each one sets out an agreement which governs the requirements and responsibilities of international trade that fall on buyers and sellers in cross-border transactions. The three types of shipping outlined above; being CIF, CFR or FOB are all agreements that are widely referred to as separate incoterms.
One of the main reasons for these universally agreed Incoterms is that it sets a framework on which international trade can progress in a formalized way and allows contract formats that are clear and understood across many languages.
CFR (Cost and Freight)
CFR is among the most popular Incoterms used, however as highlighted by our friend and Incoterm expert Bob Ronai it is often used without reference to any version of the Incoterm rules. In instances such as this, where a CFR term is used outside of the standard definitions outlined by the ICC, it would be up to the parties involved (buyers and sellers) to negotiate their contract and clearly layout each other’s responsibilities and obligations.
The term CFR term places an obligation on the seller to place the goods on board the vessel that they have contracted. Once goods are on board the vessel, responsibility for said goods then falls on the buyer. Along with placing the goods on board, the seller must also assume all export formalities (including the cost of carriage), and the buyer must hold responsibility for all the importing formalities.
In our TFG short summary of Key Changes, Advantages and Disadvantages to Incoterms 2020, we see an important clarification of the term CFR – “The seller delivers at the port of loading, but pays freight to the port of destination where the buyer is obligated to receive the goods from the carrier. Given that the word “carrier” does not appear elsewhere in this rule it might have been better-worded as receiving the goods from the vessel.”
The term CFR means that the seller has more responsibility; they will pay for and arrange transportation. This can be contrasted with a seller under a FOB shipping transaction; where the seller is merely responsible for delivery of the goods to the port of origin; they will then be transported.
In relation to a CFR trade, the exporter will pay for and arrange transportation to the port of destination that is specified by the receiving party. The exporting company will arrange and fund the transportation that is set out by the purchasing party. In relation to liability and ultimate responsibility, the purchaser will take on the responsibility when the ship has docked in the port of destination. The further costs that will include further transportation and the unloading of the vessel will fall upon the buyer.
Furthermore, under the new Incoterms 2020 rules, if a company is exporting via container shipments, CFR would likely be the incorrect term to use as the goods are often given to the carrier at a place different to the port of transport, such as a yard or even the seller’s premises.
Cost, Insurance and Freight
As touched upon above, the difference is minimal between a CIF agreement and CFR agreement. The seller assumes the responsibility for all of the arrangement and transportation costs for shipping products to the agreed-upon destination port. The buyer will then assume all further responsibilities, including those relating to cost once the ship has reached port.
The difference between CFR and CIF then being the presence of the minimum amount of marine insurance cover on the product that is being sold. The seller therefore holds all the same responsibility as in CFR but is also required to purchase insurance for the goods during transport.
How does FOB fit in?
Similar to CFR, although FOB is another one of the most frequently used Incoterms it is often used without any reference to the Incoterm rules. Again, in these instances, it is up to the parties involved in the transaction to agree on what is meant and where responsibilities/ obligations fall.
With a FOB agreed contract, the seller is required to place the goods on board the vessel that has been nominated by the buyer. From the time the cargo is on board the vessel, all responsibility for the goods is then transferred to the buyer.
As with CFR, the seller assumes all export formalities and the buyer assumes all import formalities. Cost of carriage with a FOB agreement is payable by the buyer, therefore the shipper on the bill of lading should be the buyer. It is also likely that the bill of lading would indicate “freight collect”.
In FOB instances, the seller will often require some form of evidence of export for their VAT or GST purposes. If a letter of credit is involved in the transaction, it is likely that the seller will be shown on the bill of lading as ‘the shipper’. If this is the case, the seller should ensure they are fully informed of all the duties they are responsible for.
FOB is usually characterised by the idea that it is a shipping term where the costs, responsibilities and risks are split equally between the importer and exporter. It is seen to allow a clear split of responsibility, as post-loading onto the vessel, the buyer is responsible for any costs and risk involved on the onward shipment. FOB also allows the buyer more control in managing costs.
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