Introduction to INCOTERMS

and LETTER OF CREDIT

Prof CA N. Venkatakrishnan

AT

BHAVAN’S PRIYAMVADA BIRLA INSTITUTE OF MANAGEMENT, MYSORE

19TH JANUARY 2013

World as a Global village Free flow of goods and services –seamless Quantum jump in International trade and

commerce New forms of trade-Internet / e-commerce Dynamic and Complex International markets Creative Financial Management Financial Engineering!

INTERNATIONAL FINANCIAL MANAGEMENT- Challenges

Process of Exports

Select Product

Select Market

Agents

Consumer Organisation

Promotional Activities

Basis for Trade

Terms of Trade/ Contract Terms of Payment Obligations

INCO TERMS INCO Terms introduced by International chamber of

commerce in 1936.

Incoterms or International commercial terms are a series of international sales terms widely used throughout the world. INCOTERMS are designed to create a bridge between different members of the industry by acting as a uniform language they can use.

Effective January 1 of 2000, the ICC once again updated Incoterms to follow the modern trends in international trade.

INCO TERMS

Incoterms 2000 are internationally accepted commercial terms defining the respective roles of the buyer (Importer) and seller (Exporter) in the arrangement of transportation and other responsibilities and clarify when the ownership of the merchandise takes place. 

These terms are incorporated into export-import sales agreements and contracts worldwide and are a necessary part of foreign trade.

OBJECTIVES;

The main objective of Incoterms 2000, defines the responsibilities and the obligations of a seller (Exporter) and a buyer (Importer) within the framework of international contracts of trade concerning loading, transport, type of transport, insurances and delivery.

INCO TERMS

Its first function is about a distribution of transport charges.

The second function of the Incoterms 2000 is to define the place of transfer and the transport risks involved in order to justify the ownership for support and damage of goods by shipments sent by the seller (exporter) or the buyer (importer) in an event of execution of transport.

INCO TERMS

1)   EXW - Ex Works (named place.. say Bengaluru): 

Ex works means that the seller (exporter) delivers when he places the goods at the disposal of the buyer (importer) at the seller's premises or another named place (i.e. works, factory, warehouse, etc.) not cleared for export and not loaded on any collecting vehicle.

INCO TERMS

2)FCA - Free Carrier (named place..say Bangalore): 

Free Carrier means that the seller (exporter) delivers the goods, cleared for export, to the carrier nominated by the buyer (importer) at the named place. It should be noted that the chosen place of delivery has an impact on the obligations of loading and unloading the goods at that place. If delivery occurs at the seller's premises, the seller (exporter) is responsible for loading.

If delivery occurs at any other place, the seller (exporter) is not responsible for unloading.

INCO TERMS

3)  FAS - Free Alongside Ship (...named port of shipment.. say Chennai)

Free Alongside Ship means that the seller (exporter) delivers when the goods are placed alongside the vessel at the named port of shipment. This means that the buyer (importer) has to bear all costs and risks of loss of or damage to the goods from that moment.

INCO TERMS

4)   FOB - Free On Board (...named port of shipment..say Chennai..)

Free on Board means that the seller (exporter) delivers when the goods pass the ship's rail at the named port of shipment. This means that the buyer (importer) has to bear all costs and risks of loss of or damage to the goods from that point.

The FOB term requires the seller (exporter) to clear the goods for export. If the parties do not intend to deliver the goods across the ship's rail, the FCA term should be used.

This term can be used only for sea or inland waterway transport.

INCO TERMS

5)   CFR - Cost & Freight (...named port of destination.. say Chennai)

Cost and Freight means that the seller (exporter) delivers when the goods pass the ship's rail in the port of shipment. The seller (exporter) must pay the costs and freight necessary to bring the goods to the named port of destination but the risk of loss of or damage to the goods, as well as any additional costs due to events occurring after the time of delivery, are transferred from the seller (exporter) to the buyer (importer).

The CFR term requires the seller (exporter) to clear the goods for export.

INCO TERMS

6)   CIF - Cost, Insurance & Freight (...named port of destination.. say CHENNAI..): 

Cost, Insurance and Freight means that the seller (exporter) delivers when the goods pass the ship's rail in the port of shipment. The seller (exporter) must pay the costs and freight necessary to bring the goods to the named port of destination but the risk of loss of or damage to the goods, as well as any additional costs due to events occurring after the time of delivery, are transferred from the seller (exporter) to the buyer (importer).

However, in CIF the seller (exporter) also has to procure marine insurance against the buyer's risk of loss of or damage to the goods during the carriage

INCO TERMS

Consequently, the seller (exporter) contracts for insurance and pays the insurance premium. The buyer (importer) should note that under the CIF term the seller (exporter) is required to obtain insurance only on minimum cover. Should the buyer (importer) wish to have the protection of greater cover, he would either need to agree as much expressly with the seller (exporter) or to make his own extra insurance arrangements.

The CIF term requires the seller (exporter) to clear the goods for export. If the parties do not intend to deliver the goods across the ship's rail, the CIP term should be used.

INCO TERMS

7)   DAF - Delivered at Frontier (...named place.. say SINGAPORE): 

Delivered at Frontier means that the seller (exporter) delivers when the goods are placed at the disposal of the buyer (importer) on the arriving means of transport not unloaded, cleared for export, but not cleared for import at the named point and place at the frontier, but before the customs border of the adjoining country. The term "frontier" may be used for any frontier including that of the country of export.

Therefore, it is of vital importance that the frontier in question be defined precisely by always naming the point and place in the term..

INCO TERMS

8)   DDU - Delivered Duty Unpaid (...named port of destination, say CHENNAI):  Delivered duty unpaid means that the seller (exporter) delivers the goods to the buyer (importer), not cleared for import, and not unloaded from any arriving means of transport at the named place of destination.

The seller (exporter) has to bear the costs and risks involved in bringing the goods thereto, other than, where applicable, any "duty" (which term includes the responsibility for and the risks of the carrying out of customs formalities, and the payment of formalities, customs duties, taxes and other charges) for import in the country of destination. Such "duty" has to be borne by the buyer (importer) as well as any costs and risks caused by his failure to clear the goods for import in time.

INCO TERMS

INCO TERMS

9)DDP - Delivered Duty Paid (...named port of destination, say Chennai..): Delivered duty paid means that the seller (exporter) delivers the goods to the buyer (importer), cleared for import, and not unloaded from any arriving means of transport at the named place of destination.

The seller (exporter) has to bear all the costs and risks involved in bringing the goods thereto including, where applicable (Refer to Introduction paragraph 14), any "duty" (which term includes the responsibility for and the risk of the carrying out of customs formalities and the payment of formalities, customs duties, taxes and other charges) for import in the country of destination.

Whilst the EXW term represents the minimum obligation for the seller (exporter), DDP represents the maximum obligation.

This term should not be used if the seller (exporter) is unable directly or indirectly to obtain the import license.

INCO TERMS

EXW Ex WorksFAS Free Alongside ShipFCA Free CarrierFOB Free On BoardCFR Cost and Freight(The former acronym of Cost and Freight was C&F)CIF Cost, Insurance and FreightCIP Carriage and Insurance Paid ToCPT Carriage Paid ToDAF Delivered At FrontierDDP Delivered Duty PaidDDU Delivered Duty UnpaidDEQ Delivered Ex QuayDES Delivered Ex Ship

A letter of credit is a document that a financial institution or similar party issues to a seller of goods or services which provides that the issuer will pay the seller for goods or services the seller delivers to a third-party buyer.

Letters of credit are used primarily in international trade for large transactions between a supplier in one country and a customer in another.  

The parties to a letter of credit are the supplier, usually called the beneficiary, the issuing bank, of whom the buyer is a client, and sometimes an advising bank, of whom the beneficiary is a client. 

LETTER OF CREDIT

After a contract is concluded between buyer and seller, buyer's bank provides a letter of credit to seller

Seller’s Bank

Buyer’s Bank

Seller

Carrier

Buyer

Advice

Letter of Credit advised through Bank

Seller hands over the goods (or consigns) to a carrier in exchange for a bill of lading

Seller’s Bank

Buyer’s Bank

Seller

Carrier

Buyer

Goods

Seller provides bill of lading & other documents as per the L/c to bank in exchange for payment. Seller's bank exchanges bill of lading for payment from buyer's bank.

Buyer‘s Bank exchanges bill of lading for payment from the buyer

Seller’s Bank

Buyer’s Bank

Seller

Carrier

Buyer

Documents reach the Buyer through Bank

Buyer provides bill of lading to carrier and takes delivery of goods

Seller’s Bank

Buyer’s Bank

Seller

Carrier

Buyer

Hands over Bill of Lading

Buyer Collects the Goods

a) Irrevocable LC-- Irrevocable LC is one which cannot be revoked or cancelled without the consent of the beneficiary. This form LC is generally used by Importers and Exporters as this gives more security to both the parties.

b) Confirmed LC-- is a LC which is confirmed by a third bank other than an opening bank and the negotiating bank. Sometimes the beneficiary wants the LC of buyers bank to be confirmed by a bank in his country. This process is called as confirmation.

It means that the confirming bank undertakes that in the event of proper presentation of documents as required under the LC, it will make payment irrespective of the fact whether the buyer’s bank reimburses the same or not.

It charges its commission for confirmation.

LETTER OF CREDIT

c) Transferable LC - In Transferable LC, the buyer can transfer a part of the value of LC or the full value of LC in favour of one or more beneficiaries. Transferability should be expressed specifically in the LC.

Since the buyer relies on the integrity of beneficiary, transferability in favour of someone unknown has some risks .

Normally Transferable LCs are taken by middlemen who do not want to the buyer and seller to know each other and also want to make a margin without both the parties being aware of the same.

Usually transferability in several lots is possible but the transferee again transferring the credit is not possible.

d) Back to Back LCs - In back to back Lcs, Beneficiary's banks open several LCs within the value of the mother LC.

This is also known as countervailing LCs. The terms and conditions of the second LC are

exactly the same as that of the first LC. The second LC may be a Domestic LC.

Any change is the second LC is possible only when the opener of the original LC agrees to such a change in the mother LC.

e) Sight LC or DP LC - Sight LC or Document against LC means that as soon as the Bill of Exchange (BE) of the seller is presented to the buyer ,he should make payment for the same.

And only then the documents would be handed over to the buyer. Thus no credit is given to the buyer.

f) Usance LC OR DA LC – Usance LC or Documents against Acceptance means that payment can be made after a particular period from presentation of Bill of Exchange presented to him .

By DA or Usance ,credit is given to the buyer.

CONCLUSION

INCOTERMS and LETTERS OF CREDIT form the edifice of International Trade and Financial Management .

A good understanding of these concepts is very important for anyone who is in the International business.

Sample Letters

of Credit

"In the international market place,the size of a company is not

an important factor, Desire & Knowledge are"

Thank You