Trade today has become global with international transactions taking place in huge volumes across borders. Bulk of the international trade takes place through the shipping mode of transport. Apart from the product cost of traded goods, international shipping involves several other costs including shipping costs, clearing and forwarding costs and insurance costs etc. International shipping is also susceptible to loss or damage to goods during transit. Buyers and sellers across the world negotiate trade terms with respect to these costs as well as the onus to bear the associated shipping risks. For this purpose, certain international commerce terms have been developed that lay out the responsibilities of both buyers and sellers in case of shipped goods.
The article “FOB vs CIF” looks at meaning of and differences between two of the popular international commerce terms used in international shipping – FOB and CIF.
Definitions and meanings
Free on board (FOB):
Free on board (FOB) terms in shipping indicates that the seller’s responsibility for the traded goods ends once the goods are boarded at the seller’s origin port.
When goods are sold on FOB basis, the seller is only responsible for loading the goods aboard a ship at the origin i.e., at the seller’s port. Thereafter, the buyer is required to negotiate and finalize with a shipping agency to ship the goods as well as is required to bear the cost of transit insurance as well as risk of damage or loss in transit.
Seller A ships goods from China to his buyer, Buyer B in USA. The goods are sold for a per unit price of $10, FOB. This means that once Seller A has loaded goods onto the ship at China, the responsibility of bearing all subsequent costs and risks lies with the buyer till they reach their destination in USA.
When goods are sold on FOB basis, the selling price quoted would be relatively low as it does not include any shipping or insurance costs. FOB basis terms are generally preferred by established buyers who can have established contacts with shipping companies and who can thus negotiate cost-effective shipping contracts. Smaller, less established buyers may not prefer FOB basis contracts as they may not have the expertise to take responsibility of shipping and transit risk.
Cost, insurance, freight (CIF):
Cost, insurance, freight (CIF) terms in shipping indicates that the seller is responsible for all costs and risks related to the traded goods, till they reach the buyer’s destination port. When goods are sold on CIF terms, the shipper bears all costs i.e., shipping and insurance costs up to the buyer’s port. The shipper will also bear all risk of loss or damage associated with the transit up until the buyer’s port.
The buyer’s responsibility only arises after the goods reach the destination port. The buyer is generally responsible thereafter for clearing the goods at the dock and paying all required import duties and taxes.
Continuing the same examples as above, let’s say the goods are sold for a per unit price of $13, CIF. This means that the Seller A is responsible for arranging shipping of goods till the buyer’s port as well as for paying for insurance and bearing all associated risks till the goods reach their destination port in USA.
When goods are traded on CIF basis, the price quoted by the seller will be higher than the price quoted on FOB basis. This is because the seller is assuming the risk and responsibility of ensuring goods reach the buyer’s destination port under CIF, hence he must be compensated for the associated additional costs by way of an additional profit margin.
Difference between FOB and CIF:
The key points of difference between free on board (FOB) and cost, insurance and freight (CIF) have been detailed below:
- FOB basis is the terms of sale wherein the seller’s responsibility is limited to loading the goods at the origin port, from where all costs and risks get transferred to the buyer.
- CIF basis is the terms of sale wherein the seller is responsible for shipping and insurance of the goods i.e.: seller bear’s all costs and risks till the goods reach the buyer’s destination port.
2. Onus to bear costs and risks
- Under FOB basis, the onus to bear shipping and insurance costs as well as transit risk lies with the buyer.
- Under CIF basis, these costs and risks are borne by the seller.
3. Seller’s role
- Under FOB basis, the seller’s role involves transporting goods to the dock, clearing them for export and loading them onto the ship of the buyer’s choice.
- Under CIF basis, the seller has a much wider role, wherein he is also responsible for arranging shipping contract for the goods and taking insurance for the goods in transit.
3. Buyer’s role
- Under FOB basis, the buyer’s role is extensive – to arrange for shipping from the origin port, arranging for transit insurance, unloading and clearing the goods at the destination port and transit to the final store or warehouse.
- Under CIF basis, the buyer’s role is limited and local – limited to clearing the goods at his port and arranging for local transport to his store or warehouse.
4. Quoted sales price
- Under FOB basis, the price quoted by the seller to the buyer is lower.
- Under CIF basis, the price quoted by the seller to the buyer is higher.
5. Advantages for buyer/seller
- The advantage for buying goods on FOB basis for the buyer is that he can get goods at a lower price and negotiate contracts for shipping and insurance on his own terms. The advantage for selling goods on FOB basis for the seller is that his risk and responsibility in the sale agreement is limited.
- The advantage for buying goods on CIF basis for the buyer is that he is freed up from the risk and responsibility of transporting the goods. The advantage for selling goods on CIF basis for the seller is that he can charge a higher price to the buyer and earn a greater margin on his sales.
6. Disadvantages for buyer/seller
- The disadvantage for buying goods on FOB basis for the buyer is that he has to assume significant risk and responsibility. The disadvantage for the seller is that he may earn lower margins on goods sold on FOB basis.
- The disadvantage for buying goods on CIF basis for the buyer is that the purchase could be costlier. The disadvantage for the seller is that he would be required to assume all risk and responsibility for the transport of the goods.
- FOB basis is preferred by buyers who have established businesses and who can negotiate cheaper shipping and insurance contracts than what the seller would offer.
- CIF basis is preferred by smaller and newer buyers who do not have the expertise to assume the risk and responsibility of transporting the goods.
Conclusion – FOB vs CIF:
FOB and CIF are both international commerce terms that primarily indicate the stage at which the onus of all costs and liabilities associated with the traded goods shift from the seller to the buyer. Shipping goods involve significant cost as well as risks of loss or damage in transit, thus it is important to define who the onus to bear such costs lies on by use of the appropriate terms. The preference for FOB or CIF by buyers and sellers depends on a lot of factors such as nature of goods, experience and expertise of the buyer and cost negotiations.