International trade processes can be complex, especially for first-time traders to understand. Even seemingly simple concepts with their abbreviations and variations can baffle novice traders.
One such set of abbreviations are the incoterms set by the ICC that clearly define the roles, responsibilities, duties & accountability of the exporter and importer in any given international trade transaction.
The international incoterms published by the International Chamber of Commerce (ICC) include Free on Board (FOB) & Cost, Insurance & Freight (CIF) incoterms that define the roles and responsibilities of sellers and buyers. Understanding in detail the tasks assigned to each party is crucial to ensure business takes place smoothly.
What is a FOB Incoterm?
Under the incoterm Free On Board or Freight on Board, the seller delivers goods onto a vessel nominated by the buyer at the named port. This named port can be the port of origin or the port of destination.
1. Port of origin: The term FOB origin or FOB shipping point means the buyer is at risk once the seller has dispatched the products from his end. In technical terms, the title and responsibility of the goods are immediately transferred to the buyer after loading goods onto the vessel and signing the bill of lading (BL).
2. Port of destination: On the other hand, the term FOB destination means the seller is at risk of bearing the loss until the products reach the buyer’s port.
The term was originally restricted to goods transported by ship in the US. However, now, the term has broadened and is used for goods transported by land and air too. The FOB incoterms vary from country to country. Thus, the buyer and seller need to make the FOB terms clear in the contract before shipping goods.
Depending upon the FOB, the shipping and insurance costs also vary, making it a crucial factor in determining the cost of sale and purchase.
This article covers FOB incoterms in detail, including the responsibility, roles, and FOB value calculation.
What is a CIF Incoterm?
CIF stands for Costs, Insurance, and Freight. It is an international shipping agreement that represents the charges paid by the seller to cover the shipping costs, insurance, and freight expenses while cargo is in transit. CIF applies only to goods transported by waterways and doesn’t cover other modes of transportation.
Based on the contract, the seller exports goods to the destination port as requested by the buyer and also bears the costs of any damages, loss, and insurance until the shipment reaches the destination port. Besides this, the seller bears other additional costs that may be applicable, such as inspections and rerouting, till goods reach the buyer’s port.
Once goods successfully reach the destination port, the buyer takes complete responsibility for any damages, losses, or additional expenses that might incur till goods are delivered to the final destination.
While this may sound similar to the FOB destination incoterm, under CIF, it is the responsibility of the seller to arrange for freight and shipping in the first place.
This article covers CIF incoterms in detail, including the charges, responsibilities, and duties of the buyer and the seller
The main difference between FOB and CIF lies in defining the responsibility of the parties during the various stages of transit of the goods. This also includes arranging for freight and payment of insurance and customs costs.
Each incoterm has its own set of advantages and disadvantages depending upon the type and volume of goods transported. For example, FOB gives buyers more control over transit and insurance costs. Conversely, CIF is more useful when sellers have direct and easy access to shipping.
Choosing Between FOB or CIF
Depending on factors such as the type of goods, the volume, access to vessels, associated risks, insurance charges, and, more importantly, the experience of either of the parties, the buyer and seller may agree upon either CIF or FOB incoterms.
When to Opt for FOB?
Example: A toy manufacturing company based in Mumbai, India, exports toys to a wholesale business based in London, UK. If the FOB stated on the shipping documents is FOB Mumbai (FOB origin), the London-based wholesaler is liable for any damage or loss that may occur while the toys are in transit they’re loaded onto the vehicle.
In this case, the wholesaler in London is responsible for purchasing insurance to cover the costs of any damages that might occur and expenses like taxes, customs duties, etc., at the destination port.
Similarly, if the FOB mentioned in the shipping documents is FOB London, the toy manufacturing company in Mumbai is liable for the damages until the shipment reaches the port in London. However, although the responsibility is with the seller, the arrangements for transport and freight are still done by the buyer.
Under FOB, the buyer assumes the responsibility for the transport cost and also for arranging for freight and transport. It is generally recommended to buy FOB as the buyer controls the freight prices.
When to Opt for CIF?
Suppose ‘company A’ in the US has ordered 1,000,000 units of smartphones from ‘company B’ in the US through a CIF agreement from Busan, a port in South Korea. ‘Company A’ has successfully delivered the order to the US port and loaded the consignment onto the ship for transport.
Once this process is complete, the risk of loss is transferred from ‘company A to company B.’ In exchange, ‘company A’ has purchased insurance and pays for the shipping and other costs until the consignment reaches the buyer’s destination port. The seller also bears any settlement charges before the goods arrive at the destination port.
Buyers generally avoid CIF-based imports as the sellers add a profit margin to the freight and insurance costs. However, in cases where the buyer is new and inexperienced and the seller is a large organization, opting for CIF might be a better choice as the buying company can leverage the negotiating power and seller assume liability for the safe delivery of the shipment.
Costs & Price Value
In terms of expenses borne by the seller, FOB covers expenses such as ex-factory costs of the goods, packaging charges, documentation, loading, and other transportation expenses.
On the other hand, CIF includes FOB charges and freight and marine insurance charges to be borne by the seller.
The buyers and sellers may negotiate the price of the transported goods based on the party that assumes the transportation and insurance charges.
To conclude, there is no hard and fast rule for selecting either FOB or CIF and it heavily depends on the risk appetite & bargaining power of either of the parties over aspects like freight prices & insurance.