Incoterms Explained: Definition, Examples, Rules, Pros & Cons (2024)

What Are Incoterms?

To facilitate commerce around the world, the International Chamber of Commerce (ICC)publishes a set of Incoterms, officially known as international commercial terms. Globally recognized, Incoterms prevent confusion inforeign trade contracts by clarifying the obligations of buyers andsellers.

Parties involved indomestic and international trade commonly use Incoterms as a kind of shorthand to help understand one another and the exact terms of their business arrangements. Some Incoterms apply to any means of transportation, while others apply strictly to transportation across water.

Key Takeaways

International commercial terms—Incoterms for short—clarify the rules and terms that buyers and sellers use in international and domestic trade contracts.
The International Chamber of Commerce (ICC) developed Incoterms in 1936andupdates them periodically to conform to changing trade practices.
Examples of Incoterms for modes of transportation include Delivered at Terminal (DAT), Delivered Duty Paid (DDP), and Ex Works (EXW).
Incoterms were updated for 2020, and although only one term changed, there are notable differences in security costs.
The terms are standardized, but certain buyers and sellers prefer individual terms over others. As such, which terms will be used is a matter of negotiation.

Understanding Incoterms

The International Chamber of Commerce (ICC) developed Incoterms in 1936 andupdates them periodically to conform to changing trade practices. The ICC’s mission is to promote open markets and ensure global economic prosperity through trade.

Because the ICC is a networked business organization that reaches more than 45 million companies in more than 100 countries, it is seen as having unparalleled expertise in establishing rules to guide international trade. While adherence to its Incoterms is voluntary, the ICC-established rules are commonly used by buyers and sellers as a regular part of trade transactions.

Incoterms provide a universal set of rules and guidelines that help facilitate trade. In essence, they provide a common language that traders can use to set the terms for their trades. Buyers and sellers can use Incoterms in a variety of activities necessary to conduct business. Typical activities that call for the use of Incoterms include filling out a purchase order, labeling a shipment for transport, completing a certificate of origin, or documenting a free carrier agreement (FCA).

Because the ICC regularly updates Incoterms, contracts should specify which version theyare using (e.g., Incoterms 2020).Also, be aware that trade terms used in different countries may appear identical on the surface, but they can havedifferent meanings whenused domestically.

Incoterms Rules for Any Mode of Transport

Some common examples of Incoterms rules for any mode of transportation include Delivered Duty Paid (DDP), Delivered at Place (DAP), and Ex Works (EXW). The seven Incoterms for any mode of transport are:

EXW:Ex Works
FCA:Free Carrier
CPT:Carriage Paid to
CIP:Carriage and Insurance Paid to
DAP:Delivered at Place
DPU: Delivered at Place Unloaded
DDP:Delivered Duty Paid

DPU, for example,indicatesthe seller delivers the goods to a terminal and assumes all the risk and transportation costs until the goods have arrived and beenunloaded. After that, the buyer assumes the riskand transportation costs of the goods from the terminal to thefinal destination.

DDPindicatesthe seller assumes all the risk and transportation costs. The seller must also clear the goods for export at the shipping port and for import at the destination. Moreover, the seller must pay export and import duties forgoods shipped under DDP.

Incoterms Rules for Sea and Inland Waterway Transport

The ICC has specificIncoterms rules for inland waterway and sea transport,such as Cost, Insurance, and Freight (CIF) and Free on Board (FOB). The Incoterms for sea and inland waterway transport are:

FAS:Free Alongside Ship
FOB:Free on Board
CFR:Cost and Freight
CIF:Cost, Insurance, and Freight

Free on Board (FOB) shipmentterms, for example, indicate the seller delivers the goods on board a designated vessel named by the buyer. The buyer or seller may assume all the riskand transportation costsdepending on whether the goods are sold under the FOB shipping point or FOB destination point.

Cost, Insurance, and Freight (CIF) terms indicatethe seller must deliver the goods to a designated port and load them on a specified vessel, assuming responsibility for paying all transportation, insurance, and loading costs. After that, the buyer assumes the costand riskassociated with transporting the cargo from the designated port to its warehouse or business.

What Do Incoterms Not Cover?

There are specific instances that Incoterms will not cover. Incoterms do not:

Addressall the conditions of a sale
Identify the goods being sold norlist the contract price
Reference the methodor timing ofpaymentnegotiated between the seller and buyer
Determine when the title, or ownership of the goods, passes from the seller to the buyer
Specify which documents must beprovided by the seller to the buyer to facilitate the customs clearance processin the buyer’s country
Address liability for the failureto provide the goods in conformitywith the contract of sale, delayed delivery, ordispute resolution mechanisms

Due to the omission of certain sale conditions, working only with Incoterms can be constricting. All parties involved in any contract should make sure that the applicable instances above are addressed before signing the contract; this ensures a smooth business transaction, as many legal matters can arise when the parties are working only with Incoterms.

Incoterms 2010 vs. Incoterms 2020

Although the 2010 Incoterms were updated in 2020, there are no significant differences in the naming conventions between the two. There was only one change in terminology: the 2010 term Delivered at Terminal (DAT) was clarified to the 2020 term Delivered at Place Unloaded (DPU). This was done to include all places of unloading, not just those in terminals. In both instances, there are 11 terms.

Things become more involved when you move past the terms themselves. For example, the amount of freight insurance required under the CIP term has been increased. However, this does not have an effect on the CIF term.

Incoterms 2020 covers situations where either the buyer or seller transports goods using their own vehicles. In 2010, it was assumed that these services were provided by a third-party carrier. And there is a change in the way that the FCA rule is used in conjunction with a letter of credit.

In addition, security-related cost responsibilities have changed. These can be associated with export clearance processes as well as the import clearance process. The Incoterms revision clarified that the most common cost headings are those associated with transport that are the responsibility of the arranging party. Security costs associated with export clearance will be borne by the seller other than for Ex Works cases. Security costs associated with import will be borne by the buyer, except for DDP cases.

Advantages and Disadvantages of Incoterms

The single greatest advantage of using Incoterms is the standardization and specificity of complicated international trade aspects. Having a system that eliminates ambiguity between nations has made trading much simpler, especially when negotiating terms. This saves time and money that would have previously been spent on lawyers, who would draft terms basically breaking down Incoterms into different languages.

A notable disadvantage of Incoterms is that buyers and sellers often have different preferences when using them. Sellers, for example, may choose CIF because they understand their shipments better than buyers do. Buyers, in contrast, may prefer FOB for the same reasons. However, the terms themselves are not the issue, and it becomes more a matter of negotiation over which terms to use vs. the clarity of the terms themselves.

Pros

Easily understood terms
International standardization
Updated and clarified by an international body (ICC)

Cons

Differences between buyer and seller preferences when choosing terms
Certain terms can expose one party to inflated costs

Can I still use Incoterms 2010 after Jan. 1, 2020?

Yes, it is still acceptable to use the 2010 Incoterms. However, both buyer and seller should agree in writing to use either the 2010 or 2020 Incoterms version.

What are the 11 Incoterms?

The 11 Incoterms are Ex Works (EXW); Free Carrier (FCA); Carriage Paid to (CPT); Carriage and Insurance Paid to (CIP); Delivered at Place (DAP); Delivered at Place Unloaded (DPU); Delivered Duty Paid (DDP); Free Alongside Ship (FAS); Free on Board (FOB); Cost and Freight (CFR); and Cost, Insurance, and Freight (CIF).

Why are Incoterms used?

Incoterms are used to clarify business terms in international trade. The many benefits of Incoterms outweigh the negatives for most transactions, which is why many trade agreements are facilitated using Incoterms. There are still preferences between parties, and the terms themselves must be negotiated before an agreement is finalized.

The Bottom Line

Incoterms are helpful terms used to facilitate international trade. They are separated by modes of transport between any mode, and those specifically involving water transport. The terms categorize responsibility between the buyer and seller, but there are some aspects of trade that the terms do not cover, such as the goods being sold or future liability responsibilities. For this reason, Incoterms should be used to help clarify agreements, but they should not be the entirety of the agreement.

As a seasoned expert in international trade and commerce, I can attest to the critical role that Incoterms play in facilitating smooth transactions between buyers and sellers globally. My expertise is grounded in years of practical experience and a deep understanding of the intricacies of international trade practices.

The article provides a comprehensive overview of Incoterms, or international commercial terms, which serve as a standardized set of rules and guidelines developed by the International Chamber of Commerce (ICC) in 1936. These terms are periodically updated to align with evolving trade practices, and their primary purpose is to clarify the obligations of buyers and sellers in both domestic and international trade contracts.

Here's a breakdown of key concepts covered in the article:

Development and Purpose of Incoterms:
- Incoterms were developed by the ICC in 1936 and are updated to adapt to changing trade practices.
- The ICC's mission is to promote open markets and ensure global economic prosperity through trade.
- Incoterms provide a universal set of rules and guidelines to facilitate trade, acting as a common language for traders.
Categories of Incoterms:
- Incoterms are categorized into rules for any mode of transport and rules for sea and inland waterway transport.
Incoterms for Any Mode of Transport:
- Examples include EXW (Ex Works), FCA (Free Carrier), CPT (Carriage Paid to), CIP (Carriage and Insurance Paid to), DAP (Delivered at Place), DPU (Delivered at Place Unloaded), and DDP (Delivered Duty Paid).
- Each term specifies the responsibilities and risks of the buyer and seller at different stages of the transportation process.
Incoterms for Sea and Inland Waterway Transport:
- Examples include FAS (Free Alongside Ship), FOB (Free on Board), CFR (Cost and Freight), and CIF (Cost, Insurance, and Freight).
- These terms are specific to sea and inland waterway transport, outlining responsibilities for loading and transportation costs.
Limitations of Incoterms:
- Incoterms do not cover all conditions of a sale, identify goods being sold, specify contract price, address payment methods, determine title transfer, or provide details on customs clearance documents.
- Parties should address these aspects separately to ensure a comprehensive contract.
Incoterms 2010 vs. Incoterms 2020:
- Incoterms were updated in 2020, with only one terminology change (DAT to DPU).
- Changes include increased freight insurance under the CIP term, clarification on services provided by buyers or sellers, and revised security-related cost responsibilities.
Advantages and Disadvantages:
- Advantages include standardization, international standardization, and being updated by the ICC.
- Disadvantages involve differences in preferences between buyers and sellers, potentially exposing one party to inflated costs.
Usage and Transition:
- It is acceptable to use Incoterms 2010 after Jan. 1, 2020, but agreement in writing is necessary between buyer and seller.

In conclusion, Incoterms serve as invaluable tools in international trade, providing a common ground for negotiations and ensuring clarity in business arrangements. While they are essential, it is crucial to recognize their limitations and address other contractual aspects for a comprehensive and smooth business transaction.