Introduction to INCO TERMS and LCs (5)

Introduction to
INCOTERMS
and
LETTER OF CREDIT
Prof CA N. Venkatakrishnan

AT
BHAVAN’S PRIYAMVADA BIRLA INSTITUTE OF MANAGEMENT, MYSORE
19TH JANUARY 2013

INTERNATIONAL FINANCIAL MANAGEMENT
- Challenges
 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!

Process of Exports
Select Product

Consumer
Organisation

Select Market
Promotional
Activities
Agents

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.

INCO TERMS

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.

Introduction to INCO TERMS and LCs (5)

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
 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.

INCO TERMS

 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.

EXW Ex Works
FAS Free Alongside Ship
FCA Free Carrier
FOB Free On Board
CFR Cost and Freight
The former acronym of Cost and
Freight was C&F)
CIF Cost, Insurance and Freight
CIP Carriage and Insurance Paid To
CPT Carriage Paid To
DAF Delivered At Frontier
DDP Delivered Duty Paid
DDU Delivered Duty Unpaid
DEQ Delivered Ex Quay
DES Delivered Ex Ship

LETTER OF CREDIT
 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.

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

Advice
Seller’s Bank Buyer’s Bank

Letter of Credit advised through Bank

Seller Buyer

Carrier

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


Seller Buyer

Goods
Carrier

 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

Documents reach the Buyer through
Bank

Seller Buyer

Carrier

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


Seller Buyer
Hands over Bill of Lading

Carrier
Buyer Collects the Goods

LETTER OF CREDIT
 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.

 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.

 "In the international market place,
the size of a company is not
an important factor, Desire & Knowledge are"

Introduction to INCO TERMS and LCs (5)

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