How to choose and use Incoterms on a trade contract
Incoterms were created by the International Chamber of Commerce (ICC) to help regulate the terms of international trade contracts. Although Incoterms are not mandatory, the use of Incoterms in international trade is very common, as it is a simple way to regulate the responsibilities of the buyer and seller. Learn which Incoterms to use and how to choose the right Incoterm for your contract with our helpful guide.
Choosing the right Incoterms for a trade agreement
The most important factor for choosing the right Incoterm is knowing and understanding each term fully. You can read our dedicated pages for all 11 Incoterms for detailed information on the use of each Incoterm in international trade.
Incoterms can be divided into sea freight and multimodal freight Incoterms, as well as into 4 main groups based on their main features:
Group E: EXW
The buyer holds almost all responsibility and must cover transport and insurance costs.
How to choose the right Incoterms for export and import
Before deciding which Incoterms to use, buyers and sellers have to define their needs and be prepared to agree. Many factors may influence which Incoterms to use for your cargo, either as a seller or a buyer:
Type of goods
When thinking about how to choose Incoterms for export and import, consider the way your goods will be shipped and how they will be handled, loaded and unloaded in transport. For example, bulk and containerised goods are handled differently, and some Incoterms might not be suitable for handling unpacked bulk goods. Also, if you are shipping technology or manufactured goods, you might want to select an Incoterm that includes insurance, such as CIF.
Bargaining power
Depending on the party’s experience in international trade, they might have more bargaining power and expertise for negotiating freight quotes or even have an established partnership with a carrier that allows them to always obtain the best freight quotes. If you as a buyer do not have a strong relationship with a carrier or freight company, it might be harder for you to get a good quote, which will indicate which Incoterms to use. You might consider using Incoterms that make the seller arrange the transport, such as CIP, DDP or DAP.
Customs experience
Buyers with a lot of experience in international trade and familiarity with export processes in the country of origin may prefer an Incoterm that indicates they have to carry out all export and import procedures, such as EXW. If a buyer does not want to deal with the export procedures in a foreign country, they may want to choose an Incoterm where the seller carries out the export paperwork, such as the DDP (Delivery Duty Paid).
Budget
Budget is a key factor in the use of incoterms in international trade. Buyers can choose to have the seller organise all paperwork and cover all freight and clearance charges, so they are sure that the price they are invoiced is final. For example, when choosing the DDP, the final price includes all merchandise costs, export and import clearance, insurance and freight charges. The price will be higher than under other Incoterms, such as the EXW, but there will be no extra charges, and it might be easier to budget for a company without a lot of experience.
Want more information? Check our dedicated pages
How to use Incoterms in a contract
Once you are familiar with the uses of Incoterms and have agreed with the other party on which Incoterms to use, you are ready to include them in your trade contract. Please remember that even though Incoterms are not laws, they are legally binding, and a court will consider their obligations if there should be any problems.
Steps for using Incoterms in a trade contract
- Make sure both parties are using the same version of Incoterms
The first step when learning how to use Incoterms is to make sure all parties agree on the version used. Incoterms were last updated in 2020, and the ICC recommends using only the latest version. However, if both parties agree, older versions (for example, from 2010) can be used. It is essential to decide beforehand on the version you will be using. The two most used versions are Incoterms® 2010 and Incoterms® 2020. - Put the Incoterms on the contract before signing
Add Incoterms to the contract, indicating the version used and providing any other required information. For example, some rules will require buyers and sellers to indicate both a delivery location and a destination. Make sure these locations are well written and clear on the contract. For example:- Destination: DB Schenker, Heidenkampsweg 79, 20097 Hamburg, Germany
- Delivery address: Handling terminal 34, dock 4 20097 Hamburg, Germany
Be sure you understand your responsibilities and the situations in which either party carries the risk of the cargo.
- Make sure to establish the locations
Indicate the necessary locations when adding Incoterms to the contract: the point of delivery, point of destination, final consignee address etc. For example, in a contract where the buyer and seller have agreed on using Incoterms 2020 under DAP terms, it should be written like this:Delivered at Place, (Insert named place of destination)*, Incoterms® 2020
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How to choose the right Incoterms: FAQ
What are the 4 most used Incoterms?
The most commonly used Incoterms are DDP, EXW, FAS and CIF. You can read about the uses of these Incoterms and learn how to add them to your contract by reading our complete guides.
Can Incoterms be used for domestic shipments?
Yes, you can use Incoterms for domestic shipments. The use of Incoterms is very common with companies that trade both internationally and domestically because they are an already set standard that most exporters and freight forwarders are familiar with. In most countries, there exist a list of standard domestic terms that can also be used and will be compatible with Incoterms.
Are Incoterms mandatory?
No, Incoterms are not mandatory. However, their use is recommended and encouraged because they are accepted internationally and establish the responsibilities of both parties involved in an international trade and shipping agreement in a way that prevents mistakes and miscommunications.
What Incoterms to use with a letter of credit?
According to the ICC, the Incoterms that work best with letters of credit are CIF, CIP, CFR and CPT. This is because the seller will pay for the carrier services and will likely have the Bill of Lading to control the goods and confirm the seller has paid the freight charges.
What is the best Incoterm for container cargo?
FCA (Free Carrier) is the best Incoterm for container cargo. The important thing when using Incoterms for container cargo is that the risk of the goods is clear at all times. When shipping containers, they have to be loaded and unloaded with port infrastructure at a specific terminal.
What is the best Incoterm for bulk cargo?
When shipping bulk cargo by sea, FAS – FOB – CFR – CIF are the Incoterms the ICC recommends. These Incoterms can be used for sea freight only and are designed to work with bulk cargo and non-containerised goods.
What is the cheapest Incoterm for the buyer?
It is hard to say because the total cost (commercial price + export and import + freight charges + insurance) depends greatly on the freight costs. If, as a buyer, you are sure you can obtain a better freight quote, it might be better for you to organise and pay for transportation yourself.
- In FOB, the seller leaves the goods cleared for export on board a selected vessel.
- In EXW, the seller is only responsible for leaving the goods ready for pick-up outside their premises, and the buyer is responsible for all export, import and freight charges.
- In DAP, the goods are delivered at a designated place where the buyer takes hold of them.