In the second article of this three part series, I discussed some common variations in terms and practices in the Incoterms® 2010 rules and definitions. In this article I will focus on some best practices that sellers and buyers may use to manage their delivery term risks.

 

As discussed in previous articles, there are variations in how sellers and buyers do business, yet each has to manage their risk exposure in the transaction. I will consider this from both the cost and risk point of view.

 

 

One of the critical factors for sellers and buyers is undoubtedly cost. The seller needs to carefully gather all necessary information to be able to set an appropriate cost that, whilst producing the highest profit possible, will still make the price attractive to buyers in the marketplace. The buyer's role is to gain the best deal possible.

 

Even though both parties view the transaction from opposite sides, they share a common requirement: being able to determine the cost of the transaction properly—what to include and what not to include depending on the Incoterms® 2010 rule chosen in the particular transaction.

 

There are a number of methods that may be used to capture cost data, but one of the most commonly used approaches remains the checklist. This is where the seller or the buyer builds up the cost from the chosen Incoterms® 2010 delivery point to destination, unless that happens to be a DDP transaction, in which case the buyer essentially has the total cost already. It appears, though, that a number of the checklists that are commonly used lack the detail required to make sure all costs are captured and that, more importantly, double charging does not occur.

 

For the best situation to develop, the seller and the buyer need to communicate with each other about what exactly is being offered and accepted. It may seem basic and common sense, but without this conversation it is not possible for the buyer to ascertain whether the seller's price includes unloading costs, for example, if these are included in the freight charges. If the seller cannot provide this sort of detail, this should signal to the buyer that the seller has not paid enough attention to the costs, and that raises all sort of questions about the accuracy of other cost information.

 

Against each consignment the details of charges should be specified, especially where contentious or uncertain fees may occur such as loading and unloading, terminal handling charges, or even delays in border clearance.

 

Another method of making sure costs are reasonable from the buyer's perspective is to seek differential costing with physical details of the consignment to be shipped. For example, a consignment of 10,000 kilograms with a volume of five cubic metres needs to be moved between two points. What will the difference in cost be if the price is FCA ex seller's premises, FCA port of departure, CPT or CIP? The buyer is in a position to do their own "transport shopping" and work out whether it is better to buy using one Incoterms® 2010 rule or another.

 

A prudent seller will operate transparently, enabling the buyer to achieve certainty on the accrual of charges so product costing can be accurately determined down to the last dollar.

 

In choosing to trade with another party, the issue of risk is an inevitable aspect of any transaction. Risks and cost are inextricably linked as ultimately risk is quantified in monetary terms.

 

The checklist approach described above is a good risk-management tool. Another important consideration is being clear about the delivery point and the risk transfer point. Yes, the Incoterms® 2010 book says it all, but I bet a lot of individuals have not read this thoroughly or considered the risk element enough. So, develop your checklist, make it comprehensive, and customise it to particular trade routes or carriers so that you know what is being charged and why.

 

If you are a seller and you are agreeing to provide a transport document when it is not necessary (such as in FCA or FOB transactions), you are entering into a contract of carriage. You should carefully consider the implications. Will you prepay the freight on behalf of the customer even when you are offering extended payment terms, or will you make a separate arrangement for the payment of freight? Will this actually work?

 

There are cash flow implications in pursuing this option as the seller pays the carrier now but does not recover the cost of the sale (that includes freight charges) until the future settlement date. Under these circumstances the seller is effectively subsidising the cost of freight.

 

If we consider the issue of letter of credit trading under these circumstances, this would need to be set up with a split payment option allowing for the immediate reimbursement of freight charges on lodgement of transport documents with the bank. However, the bank needs to check the documents for compliance before making the payment.

 

It is unlikely that the bank will agree to these arrangements. Seeking payment of freight charges outside the letter of credit may not work in reality, because unless a letter of credit is being used to satisfy government requirements, it is used where there is insufficient payment trust between the seller and the buyer—a risky situation indeed. It may mean that the seller has to add a finance factor on the freight charges to recoup the "out of pocket expenses."

 

In conclusion, to manage your risks and costs you need to understand the transaction and have complete knowledge about its details. Be specific about what you include in your selling or buying prices; that is the only way to eliminate cost surprises.