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Incoterms® Explained

Let Us Help You Make the Most of Incoterms® 2020

Incoterms® were developed as a set of norms for international deliveries, in order to guarantee the smooth sailing of international trade. They are often used as abbreviations, such as FOB or CIF, and can sometimes lead to misunderstandings amongst business partners. Follow the lead of the Forwarding Experts and make sure that current Incoterms® always play in your favor.

What Do Incoterms® 2020 Actually Cover?

Under the contract of sales, Incoterms® determine the rights and obligations of the parties as far as the delivery of goods from the seller to buyer is concerned. They give a common framework to understand how transport is organized and by whom, who bears the risks inherent to it, and who is in charge of the shipment’s security and customs compliance.

Incoterms® always follow the same structure – a three-letter acronym and a location name. The location name is important because it indicates where transportation costs are handed over from the seller to the buyer. However, from one Incoterm to the other, that same location name may not indicate where risks are being transferred, nor give information on where and by whom transport insurance should be organized.

The current Incoterms® 2020 contains 11 terms. Four of them are specifically designed for ocean freight, as they exclusively apply to sea and territorial water transport; the remaining seven are applicable to cargo delivered via any type of transport mode – including water.

The Big Differentiator: Sharing the Cost of Transportation

Incoterms® differ mainly by the distribution of transportation costs and organization. This covers trucking, ocean, air or rail freight but not only: loading, unloading, and packaging the goods are also part of the equation.

In international trade, transportation costs naturally have a significant impact on the final bill. Buying goods under Ex-Works (EXW) terms or Delivered at Place Unloaded (DPU) will generate very different costs for you as a buyer. The same goes if you are the selling party.

At the same time, deciding which of the parties is the best equipped to organize fast, safe and cost-efficient transportation can also help to bring you peace of mind. When in doubt, let the expertise of a freight forwarder connect your goods to where they are needed the most.

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Capital Information: Risks, Insurance, and Insurance Cost

While knowing who is responsible for organizing and paying for transportation is important, knowing who is bearing the risks of the shipment and when is essential.

In some current Incoterms®, such as Carriage and Insurance Paid To (CIP), the buyer is assured that the seller will be responsible for insuring the cargo. Other Incoterms® do not inform on insurance policies and therefore leaves them up for discussion between the parties.

Additionally, while risk and transportation costs can be transferred at the same location (it is the case of EXW or DPU shipments, for example), not all current Incoterms® follow this rule. The Carriage Paid To (CPT) Incoterm already transfers risks from seller to buyer when the cargo is handed over to the carrier, in its origin country, whereas transportation costs are borne by the seller until a named place of destination.

Customs Duties and Compliance Responsibilities

Last but not least, current Incoterms® dictate who is responsible for filing customs declaration and clearing all duties, both at export and import. Under these terms, cargo must also be compliant with any security control measures and pass all inspections.

In most of the Incoterms®, the seller is responsible for export duties, while the buyer is responsible for import customs clearance. Only under EXW terms does the buyer take both import and export duties under his responsibility, while the seller bears these responsibilities under the Delivered Duties Paid (DDP) terms.

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Classifying Incoterms® 2020

Differences exist between each individual term, meaning Incoterms® can easily be grouped in four categories, based on their acronym’s first letter – not so difficult to remember.

To become an Incoterm Expert, you can read the full description of each rule in our Help Center Incoterms® Explainer

E Group – EXW

Incoterms® meaning: EXW shipments place almost all of the obligations under the buyer’s responsibility. They are transferred to the recipient at the initial time and place of shipment.

The seller ensures the transfer of goods to the buyer at a selected location.

The buyer organizes the entire delivery from the place of loading, including the main transportation, and bears all risks from the moment the goods are accepted from the seller. This includes export customs clearance.

F Group – FCA, FAS & FOB

Incoterms® meaning: With Free Carrier (FCA), Free Alongside Ship (FAS), and Free On Board (FOB), the main carriage is not paid by the seller, and the goods are transferred at a place agreed by the parties in the seller’s country.

The seller clears the shipment for export customs. They deliver the cargo at a named place of shipment.

The buyer is responsible for concluding the main contract of carriage, for choosing a carrier or a forwarder, and monitors the freight costs. They are responsible for import customs duties.

C Group – CPT, CIP, CFR & CIF

Incoterms® meaning: With CPT, CIP, Cost & Freight (CFR), and Cost, Insurance and Freight (CIF), the main carriage is paid by the seller, but the risks are transferred when the goods are handed over to the first carrier. Two of these terms oblige the seller to insure the goods in favor of the buyer.

The seller is responsible for concluding the main contract of carriage, for choosing a carrier or a forwarder, and they monitor the freight costs. They organize the delivery of the goods to the place of loading for the main carriage, where risks will also be transferred to the buyer. They are responsible for export customs clearance.

The buyer bears the risk of cargo damage or loss during the main carriage. They also rely on the seller to provide correct information to the main carrier. They are responsible for import customs clearance.

D Group – DPU, DAP, DDP

Incoterms® meaning: The so-called "full delivery" group includes Delivered at Place Unloaded (DPU), Delivered at Place (DAP), and DDP. Most costs and obligations are borne by the seller and transferred to the buyer when they receive their goods at the country of destination.

The seller is responsible for concluding the main contract of carriage, for choosing a carrier or a forwarder and monitoring the freight costs. They organize the delivery of the goods to the place of loading for the main carriage, where risks will also be transferred to the buyer. They are responsible for export customs clearance, and also import in the case of DDP.

The buyer is responsible for unloading their cargo at the place of transfer of goods (except with DPU).

The Most Popular Incoterms® in 2020

Incoterms® rules regulate the distribution of the delivery costs and determine when the risks of accidental loss or damage to the goods are transferred from buyer to seller. They state when the supplier is considered to have fulfilled their delivery obligations.

In Ocean Freight transportation, we at DHL Global Forwarding have found the following freight Incoterms® to be the most commonly used so far in 2020:

  1. Free On Board (FOB)
  2. Ex-Works (EXW)
  3. Free Carrier (FCA)
  4. Cost & Freight (CFR)
  5. Cost Insurance & Freight (CIF)

Explore the exact definition of each term in our Help Center Incoterms Explainer.

But how does one exactly choose the correct Incoterm®? While the decision-making process can be complex, and often tied to the traditional practices of a business sector or a specific partner, we tried to categorize and simplify how your preferred allocation of costs and responsibilities can translate into a specific Incoterm®.

Questions to Ask Yourself and Your Business Partner

Starting Easy: The Correct Transportation Mode

Free Alongside Ship (FAS), FOB, CFR and CIF are designed for sea or waterway transportation. If these terms are agreed upon, the seller is obliged to present a bill of lading or other maritime transport document upon delivery.

They should in all logic not be used if your shipment is not going to be transported on a barge or a ship during its international leg. The other freight Incoterms® can all be used for ocean, air, and rail transportation.

The ocean- and waterway-specific Incoterms rules generally imply that the ocean carrier is a third party. In the eventuality of vessel chartering however, the party (buyer or seller) chartering the vessel will be considered as the carrier. The main discussion point to be clarified between the parties is the responsibility for cargo loading onto and unloading from the ship.

Thinking Strategically: The Best Guy for the Job

Main-leg and inland transportation does not only include the time your container or pallets spend on a ship or a truck: they also include monitoring the loading or unloading process and the cargo’s general integrity throughout its journey.

Let us consider the specific example of perishables being delivered. If the seller owns some of the necessary equipment and/or has access to the expertise to transport such commodities over long distances (think specifically-trained staff, reefer containers…), and the buyer does not, it is reasonable to give the seller the responsibility to manage transport through the Delivered At Place (DAP) terms.

More generally, choosing between F-, C- or D-Group terms can also be decided upon based on the seller’s or buyer’s capacity to conclude the most favorable contract of carriage. In some countries, the seller or buyer can be legally bound to use a national shipping line.

Finally, who is the most capable to monitor and control demurrage, detention and storage expenses? Let your freight forwarder put you in control of your supply chain. 

Explore our Demurrage Explainer

Far from Just a Formality: Insurance and Customs Duties

Insure your goods. As a buyer, if you want to clearly show in your contract that your supplier is responsible for insuring your goods, support your transaction with the relevant freight Incoterms®: choose CIF or Carriage and Insurance Paid To (CIP). Specify directly in your contract which risks the insurance should cover.

In international trade, export customs duties are usually borne by the seller, and import duties are borne by the buyer. Clearing the goods for import or export also includes permits and licenses necessary to the compliance of your shipment.

As a consequence, you may wish in certain instances to let the buyer take the responsibility of this process at both import and export, which is enabled by the EXW terms.

If it is rather the seller who should take care of these formalities at both end of the journey, select the Delivered Duties Paid (DDP) Incoterm®.

You have chosen the perfect Incoterm for your shipment? Make sure you specify that you are using the 2020 edition.

Three Tips to Use Incoterms® 2020 to Your Advantage

1. Make Documented Decisions to Select Your Incoterms®

Knowledge is your best ally – make sure you know your Incoterms® to select the most adapted one. 

View Help Center Incoterms®

Beyond theoretical knowledge, ask yourself a few questions before deciding. Which of the parties is the most likely to make the right decisions? What is the best way to transport your specific cargo? Is insurance needed (we found that it usually is)?

2. Be Specific about Your Incoterms® of Choice

The Correct Location
To make sure the correct Incoterm is applied, it must be clearly indicated in your contract of sales, using the following structure:

[Selected Incoterms®], [Named location], [in accordance with Incoterms® 2020]e.g. CIF, Long Beach, Incoterms® 2020

An Incoterm is only valid once the contracting parties have determined a city location or a port. Indicate these places as accurately as possible.

The Correct Version
It is still possible to use
the Incoterms® 2010, the Incoterms® 2000, and even earlier versions of the Incoterms®. Therefore, when specifying the terms of delivery, it is necessary to indicate which version of the Incoterms® should be used.

3. Remember What Incoterms® Do NOT Cover

The Incoterms® only indicate how transport costs and risks are distributed between the seller and the buyer, as explored above.

The Incoterms® rules do not indicate the price to be paid for the goods, nor their payment method.

They also do not regulate the transfer of ownership of goods or the dispositions in case of a breach of contract. These matters are usually defined in express terms in the sales contract, or in the laws applicable to it. Moreover, the parties are strictly bound by local laws – they may take precedence over any aspect of the contract of sale, including the selected Incoterms®.

Three Mistakes to Avoid When Choosing a Incoterm®

1. Inconsistent Delivery Terms Across Your Documentation

Your shipment’s invoice will be used as a basis for the determination of its customs value.

As a consequence, if your contract indicates that transportation has been agreed upon with EXW terms, an invoice mentioning a CIP delivery will raise questions and potentially delay the clearance of your cargo. This is important if your contract does not state that other conditions for the delivery or pricing of the goods may be established on the invoice.

2. Misconceptions Between the Parties on the Rights and Obligations of the Selected Incoterm®

Incoterms rules were created to provide a common framework of reference for international deliveries, and thus facilitate global trade. With a new edition now in application, redoubling your communication efforts on the concrete implications of the selected Incoterms® will always pay out! EXW and FCA make for a great example.

According to the FCA terms, the seller transfers the goods to the carrier, or another person nominated by the buyer, directly in the seller’s premises in another designated place. In The 2020 edition of the Incoterms® rules, it is established that the buyer must inform the seller of a time period or precise date for the carrier (or other designated party) to pick up the goods.

Unlike the seemingly similar EXW terms, FCA does however not establish the seller’s obligation to notify the buyer of the readiness of the goods for delivery – complaints from the buyer for that matter would be unfounded. Play it safe, let your customer know!

3. Choosing the Wrong Transportation Mode under Terms CIF or CIP Terms

Under CIP terms, the seller must conclude a contract of carriage and bear the costs inherent to the shipment’s delivery at destination – irrespective of the chosen transportation mode.

The basis of CIF implies the obligation of the seller to conclude an agreement and pay all costs and freight necessary to deliver the goods to the specified sea or river port of destination. If a sale has been concluded on CIF terms, delivery of goods by road may be recognized as improper fulfillment of the delivery obligation.

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