Incoterms - Meaning, Types, Example, Vs Payment Terms (2024)

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.

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.

• 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 aboutcosts, 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.

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)

• DAP (Delivered at Place)
• DPU (Delivered at Place Unloaded)
• DDP (Delivered Duty Paid)

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)

Recommended Articles

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 -

• Commercial Invoice
• Bilateral Contract
• Embargo