Globalization has turned the world into a village. This is particularly true when it comes to commerce. How many products of the products you use in your daily life have been made outside your country? A lot, I believe.
Globalization has made it cheaper to acquire goods and products from all over the world. It has made it easier for even people who are not in business to buy things from other countries.
That amazing antique couch you saw in Turkey during your visit – you can easily buy it and have it shipped to your home country.
With the internet and ecommerce companies like Amazon, Alibaba, and so on, international commerce has become even more mainstream.
Today, almost everyone can buy or sell products from and to any part of the world.
If you intend to get involved in international business, you need to be aware of the nitty-gritties of importing and exporting, and a good of awareness of some of the jargon and terms you are going to come across in this business.
One of the terms you need to be aware of is FOB shipping point.
In this article, we are going to take a look at this term, what it means for you, where it applies, and so on. Let’s dive in.
- 1 DEFINITION OF FOB SHIPPING POINT
- 2 WHAT IS FOB DESTINATION?
- 3 INTERNATIONAL USAGE VS NORTH AMERICA USAGE
- 4 SUMMARY OF BUYER’S VS SELLER’S RESPONSIBILITIES IN FOB SHIPPING
- 5 OTHER TERMS YOU WILL ENCOUNTER WHEN DEALING WITH FOB SHIPPING POINT
- 6 THE EFFECT OF INTERNATIONAL TRADE ON FOB SHIPPING
- 7 FOB SHIPPING POINT IN THE ECOMMERCE INDUSTRY
- 8 WRAPPING UP
DEFINITION OF FOB SHIPPING POINT
FOB is an abbreviation used in shipping. It stands for “Free On Board”. The term FOB is only used in reference to shipments which are made via waterway. Goods transported by rail, air, or road do not apply.
It is good to note that there are two types of FOB” FOB shipping point and FOB destination. Both are among International Commercial Terms (Incoterms) defined by the International Chamber of Commerce (ICC). The concern of this article is the first term: FOB shipping point.
When a shipment is designated FOB shipping point, it means that ownership of the goods transfers to the buyer immediately after the goods are loaded onto the vessel at the shipping point.
Since the goods now legally belong to the buyer, he or she is responsible for their transportation – put simply, the buyer has to pay for the delivery charges, not the seller.
Furthermore, all the risks involved in transportation of the goods are transferred to the buyer once the goods are loaded onto the vessel.
Should any of the goods get damaged or lost during shipment, it is the buyer, not the seller who should file any claims for reimbursement.
It is at this point (shipment leaving the shipping point) that the buyer should record an increase in inventory.
FOB shipping point, also referred to as FOB port, indicates that the seller is only responsible for the shipment’s transportation to the port – and that includes loading costs.
The buyer is responsible for insurance, unloading, marine freight transport cost, and transportation of the goods from the arrival port to their final destination.
The risks transfer to the buyer as the goods are loaded on board the ship at the port of shipment (shipping point).
For instance, if goods are designated as “FOB Miami” it means the seller is responsible for the cost of transporting the goods to the port of Miami.
Any costs incurred for loading the goods on to the cargo ship are also the seller’s responsibility.
These loading costs include customs clearance, inland haulage, demurrage if any, origin documentation charges, and origin port handling charges – in this case, the origin port is Miami.
Once the shipment is loaded onto a ship at the port of Miami, the buyer becomes responsible for all costs and risks involved in transportation.
Furthermore, the goods now belong to the buyer and the buyer’s accounting books can at this point record an increase in inventory.
WHAT IS FOB DESTINATION?
To better understand FOB shipping point, it is necessary to understand the opposite term: FOB destination.
As you can probably tell from what I have so far told you about FOB shipping point, it does not favor the buyer.
Getting ownership of the shipment as soon as it is loaded on the ship at brings with it costs and risks the buyer would not incur if ownership transferred only after reaching them.
FOB destination, on the other hand is exactly what a buyer would want. Instead of receiving ownership when the goods are loaded onto the ship at the shipping point, the buyer receives shop when the goods reach him. In other words, ownership does not transfer to the buyer until the shipment arrives at the buyer’s destination.
For instance, if the buyer’s location is New Orleans, the terms will read “FOB New Orleans”.
In FOB destination, the seller is responsible for all fees and costs until the goods arrive at their destination. On arriving at the port (or the buyer’s location), all the fees (and this includes customs and taxes) at this point are now the buyer’s responsibility.
Only after the purchased goods have reached the buyer’s location in perfect condition does the buyer accept them. Only then does the buyer record the items as inventory in his or her system. At this point, the sale is officially complete.
INTERNATIONAL USAGE VS NORTH AMERICA USAGE
There is potential for confusion between North America’s domestic usage of “FOB” and the international usage.
To remove this confusion, it is now recommended that the Incoterms’ use be stated explicitly together with the edition of the standard. For example, “FOB New York (Incoterms 2000)” means that in this case, they are referring to the incoterms 2010 edition meaning of the term.
FOB is also used in the United States’ modern domestic shipping. It refers to the point at which the shipping cost is no longer the seller’s responsibility.
In North America, the sales agreement includes the term FOB – it determines the point at which liability and responsibility for the cargo ceases to be the seller’s and transfers to the buyer.
In North America, they have two types of FOB: “FOB origin” and “FOB destination.” In “FOB origin”, the transfer of liability responsibility happens when the cargo is safely on board the transport.
In “FOB destination”, transfer happens when the cargo is retrieved from the transport on arriving at the buyer’s location.
“FOB origin,” which is a synonym for “FOB shipping point” indicates that the sale completes at the seller’s shipping dock. As a result, the buyer must cater for any liability incurred during transport and for freight costs.
However, usage of the FOB terms is not mandatory, and they are often not used.
In such a case, the agreement’s specific times may vary widely – for instance, which of the two parties is responsible for shipment costs and loading costs, or where is responsibility for the goods transferred?
That last one (where responsibility is transferred) is key in determining liability for cargo that gets lost or damaged in transit.
Note that while international shipments use “FOB” in the definition provided by the Incoterms standards (always standing for “Free On Board”), this is not always the case for North America shipments. Domestic shipments in Canada and the US will often operate with a different meaning that is specific to North America and not consistent with the Incoterms standards.
SUMMARY OF BUYER’S VS SELLER’S RESPONSIBILITIES IN FOB SHIPPING
As we mentioned, the buyer’s responsibilities over the shipment begin as soon as it is loaded onto the vessel.
The seller’s responsibilities, therefore lead up to that point.
However, you should note that they extend beyond just bringing the items to the port of loading.
On FOB shipping point, the seller/supplier is responsible for all the costs involved in getting the cargo onto the transport vessel.
Your quote (as the buyer) will then cover everything after the goods are loaded onto the vessel, all the way to delivery at the address you specified.
Here is a summary of first buyer’s and then seller’s responsibilities in FOB shipping:
- Pay the full price agreed upon between the two parties in the agreement of sale.
- The buyer takes upon personal risk and is responsible for any import license or legal permits, customs procedures for importing the goods, and for the cost of the goods’ transit across international boundaries.
- The buyer has to accept delivery of the products once they are dispatched.
- The buyer takes up all risks of damage or loss of goods once they are loaded onto the vessel at the port of origin.
- The buyer is charge of all costs after the goods are loaded onto the vessel at the port of shipment.
- The buyer provides the seller with adequate notice of the vessel’s name, the loading point, and the required delivery time.
- The buyer must take/accept evidence of delivery.
- The buyer is responsible for any pre-shipment inspection, except when it is ordered by the country of export’s administration.
- The seller must supply the goods and the commercial bill for the goods.
- The seller is responsible for any export license or legal permits, customs procedures for exporting the goods.
- The seller must deliver the goods to the port of origin within the agreed upon duration.
- The seller is responsible for all risk in case of damage or loss until loading of the goods onto the vessel at the port of shipment.
- The seller is responsible for all expenses until the goods are loaded onto the vessel at the port of shipment.
- The seller must provide the buyer with adequate notice that the goods have been dispatched, so the buyer can make preparations to receive them.
- The seller should provide the normal evidence of delivery.
- The seller should help the buyer/importer with acquiring any documentation necessary in the country of origin.
OTHER TERMS YOU WILL ENCOUNTER WHEN DEALING WITH FOB SHIPPING POINT
When dealing with FOB shipping point, there are some other terms you are likely to come across, which in some cases you might have to define when you are developing your own shipment process. These terms include:
1. Liability Issues
If you are the buyer, FOB shipping point means you are responsible for the goods during shipping.
If any damage or loss occurs, the legal liability is yours. You are therefore the one who will be required to file a claim so as to be reimbursed.
On the other hand, in the case of FOB destination, it is the seller who will have the liability in case of damage or loss of goods before they reach the port of destination or buyer’s location. In such a case, the seller will have to provide the buyer with a new shipment.
If you are a seller using FOB destination and you are shipping using a third-party carrier such as US Postal Service or UPS, consider getting insurance on any expensive goods that you ship.
This ensures that you can file a claim in the event of loss or damage of the cargo.
2. Bill of Lading
As a seller, when you send the shipment via a third-party carrier like UPS, you should use a bill of lading.
The bill of lading is a legally binding document that the seller signs when delivering the goods to the carrier.
The carrier also signs the bill of lading when delivering the goods to the buyer. It is basically a shipment receipt for the buyer.
The bill of lading provides protection to the seller in case there is a dispute.
3. Recognizing Revenue
In addition to their value in clarifying legal liability, shipping terms also determine the point at which one is able to record revenue for the transaction on the inventory asset account on their balance sheet.
According to the generally accepted accounting principles (GAAP), a business cannot record revenue until the transfer of risks and rewards of the goods from the seller to the buyer.
In the case of FOB shipping point, the sale becomes complete when the shipment is sent off. As for FOB destination, the sale becomes complete when the goods are delivered and come into the buyer’s possession.
The timing difference from shipping terms is typically just a few days and unlikely to affect periodic financial statements. However, a CPA preparing GAAP financial statements will put in more scrutiny.
Accountants often review shipping records and documentation during a “cutoff period”. This is usually around the end of the fiscal year – right before and right after.
If in your sales there is FOB destination inventory which was shipped just before the cutoff (a day or two), or any inventory that is yet to be shipped, the business will not record the sale until the next fiscal year begins.
THE EFFECT OF INTERNATIONAL TRADE ON FOB SHIPPING
While domestic trade is straightforward, shipping to other countries is not as clear-cut, since the international trade laws you have to deal with will depend on which country you are shipping to or from. The international trade laws will also depend on the product.
Therefore, international trade will almost definitely have an impact on the FOB process.
It will impact shipping in general, since there are several factors you must consider when shipping internationally. These factors include:
1. Customs Clearance
Every parcel shipped from one country to another has to clear customs. It doesn’t matter what you are shipping – shoes, candy, couches, refrigerators, you name it.
If customs seize an item (for whatever reason), this could lead to hefty penalties and fines, and that will definitely raise the overall cost of your FOB shipment.
This is one of the reasons why ordering goods from abroad is more expensive than ordering within your own country.
Therefore, if you are developing an international shipping plan for your business, keep these extra costs and risks in mind as necessary for your calculations.
2. International Shipping Costs
Freight costs are likely to increase drastically when you are shipping goods overseas.
The increase in shipping costs is caused by the fact that the goods are being shipped a longer distance.
Furthermore, there are extra costs, such as paying for customs clearance and other inspections or certifications.
When all these costs are added up, the shipping cost becomes far more expensive than what it would cost you to ship the same goods domestically.
As a seller, one way to deal with this is estimating the cost and choosing the freight prepaid route, in which case the cost gets included in the purchase.
As a result, the buyer won’t have to directly pay for shipping. Another option is for the buyer to pay the shipping cost.
3. Transport Costs
In addition to the cost of overseas shipping, you must also keep the transport costs in mind.
Note that the transport costs do not just cover the distance between the shipping point and a port in the country you are shipping them to (unless that was the agreement between the buyer and seller).
In some cases, the goods also have to be transported to the buyer’s location (delivery).
This will therefore involve additional transportation costs. At this point, decisions must be made concerning what means of transportation to use (third-party truck, train, and so on) and which service-provider to hire for the purpose.
Such factors may cause a drastic rise in transportation costs when shipping internationally.
Furthermore, these factors lead to increase the risk of damage or loss of the goods, something else you must factor in your overall cost estimation when planning for international shipping.
When you are shipping internationally, there may be documents which you first need to clear at customs.
You must therefore ensure that you are aware if any documentation required (as a seller) for the type of goods you are sending as well as for the country you are sending the goods to. The required documents will vary for different countries.
FOB SHIPPING POINT IN THE ECOMMERCE INDUSTRY
Nowadays, if you want to buy something, the easiest way to find it is online. Ecommerce is big business, a wave that has revolutionized most industries.
Ecommerce companies like Amazon and eBay are like shops on the internet which you can access from the comfort of your home whenever you want to buy something.
They save you the time or money you would have spent doing the legwork of physically looking for shops that stock the product you need or sellers that that have it in their warehouses.
Since ecommerce shops operate primarily over the internet, they are accessible to people from all over the world.
If someone outside the US makes an order from Amazon, for instance, the goods have to be shipped outside the country, and therefore various international commerce terms, including FOB shipping point, have to apply.
For instance, if a person in the US is ordering a refrigerator (domestic shipment), he or she will probably agree to a sale under the FOB shipping point. When ordering items internationally, however, the options are different.
A refrigerator is a pricey purchase, so the buyer must be prepared to fork out a substantial amount of the money up front. This is because online transactions are tricky.
They rely on trust, and are a big risk – the customer cannot assure the business that they will for sure pay for the refrigerator on delivery.
In ecommerce, FOB shipping point enables the business to collect payment from the sale immediately after the assembly and loading of the item onto the transport.
This gives the business protection, in the event of a failed payment after the business has already paid for the transportation.
Furthermore, FOB shipping point indicates that the buyer bears responsibility for freight costs.
Therefore, the business can save money, in case the goods get damaged or lost in transit. When such cases occur, it is the customer’s responsibility to file a claim.
As I have said that FOB shipping point means that the buyer must make a financial commitment in advance.
On the other hand, it makes it possible for the goods to be sent to the buyer’s home, and the buyer does not even need to be present when they are delivered.
When you order something online, you have to first provide your billing information.
Only after the seller begins the actual shipping process do they bill you.
You as the customer don’t even have to be there to accept the package when it arrives.
This, however, depends on the type of home you live in and on the type of product you are purchasing.
There is a lot of due diligence to be done if you’re involved in the import and export business. Learning about what is entailed in FOB shipping point is a good first step, but you have to keep learning and dig deeper.
As I have mentioned, the laws and documents and processes that impact on importation and exportation vary for different countries.
That means every time you are exporting or importing from a new country, you will have to do some fresh research to find out what you need to do, so as to have a smooth process.
To recap, FOB shipping point means that ownership of the goods and the liability in case of damage or loss transfers to the buyer as soon as the seller loads the goods on the ship at the port of origin.