Free On Board is a trade term indicating whom of the seller or the buyer is liable for the goods while being shipped between the two parties. Usual reference to this is FOB. In most cases, the supplier pays the shipping costs. This includes the insurance costs and covering fees from the production point to the delivery destination. Once delivered, the buyer is responsible for the goods.
What does the Free On Board involve?
FOB defines the supply chain point where the seller relinquishes ownership of purchased goods and where the buyer accepts this ownership. Meaning that FOB terms define the point where the responsibility passes from one party to the other. When talking about FOB, two types can be distinguished: FOB shipping point or origin and FOB destination.
“FOB shipping point or origin” induces that the buyer is liable and at risk of loss when the shipment of goods. There are two cases:
Case 1 – FOB Origin, Freight Collect
This is referring to the legal fact that the buyer takes responsibility when the freight carrier picks up the goods and will sign the lading bill at the specified pick-up location.
FOB Freight Collect:
Referring to the legal fact that the buyer is responsible not only for the total of freight charges but all logistics risks and claims filing in case of any loss or damage.
Case 2 – FOB Origin, Freight Pre-paid
Referring to the legal fact that ownership is taken by the buyer at the carrier pick-up time.
FOB freight pre-paid:
This refers to the legal fact that the seller is fully responsible for any freight charges and claims exposure.
The “FOB destination” indicates that it is the buyer who is liable for the goods and would retain the risk until the delivery of the goods to the buyer. Once again, two cases can be discussed:
Case 1 – FOB Destination, Freight Collect
The legal fact that the seller is held responsible for the goods title and control. This means that he gets to select the carrier and retain the risk of loss concerning transportation and claims filing.
FOB freight collect:
Referring to the legal fact that the buyer is held fully responsible for any freight charges.
Case 2 – FOB Destination, Freight Prepaid
The legal fact that ownership is retained by the seller until a delivery claim free is acquired.
FOB freight pre-paid:
Refers to the legal fact that the seller is held responsible for any freight charges.
For example, if Clothing Manufacturing ships $100,000 worth of shirts to its retailer and uses the “FOB shipping origin or point” in the contract, the retailer is liable for any potential losses while the shipment process and has to purchase insurance to protect its business. Otherwise, if the term “FOB destination” is used, Clothing Manufacturing retain the risk of loss until the goods’ delivery and has to ensure the shipment of potential losses. Those losses also include tariff disputes, non-clearance of the goods in customs, dock worker strikes, etc.
In fact, International transportation contracts usually include trade terms referring to matters such as the delivery place and time, the payment method, the risk of loss shift from the seller to the buyer and who is liable for freights and insurance costs. The common international trade terms are called Incoterms and are defined and published by the International Chamber of Commerce. However, U.S. firms shipping goods are under the Uniform Commercial Code. Therefore, contract parties must specify the governing law used for the goods shipment as more than one set of rules might apply.
Every vendor to client transaction should have specified FOB terms in their PO purchase document as both purchase and shipping terms are critical in order to specify ownership, risk and logistics costs. Ensuring that your FOB terms match your company needs is very critical for gaining competitive advantages regarding shipping and accepting goods.
What documents are required when shipping FOB?
For transportation and US Customs clearance, the required list of documents is as follows:
- Invoices must be commercial;
- The PO number must be visible on every invoice;
- Must clearly state the Origin country, Beneficiary name and telephone number on the invoice;
- HTS Codes should be included for every item listed.
- The SKU/UPC and quantity for each item should be listed
- Payment terms need to be included in invoices;
- For required wire transfer, all banking information must be stated on the invoice.
- The packing list should include the container and seal number;
- Each PO MUST have a separate packing list and the PO number must be listed;
- Each item needs to be described in details;
- HTS Codes must be included for all listed item.
Bill of Lading:
- Need to be Telex Released
Importer Security Filing (ISF):
- The ISF form must be released a minimum of 72 hours prior to the vessel sailing from an origin. The Vendor will be charge fine if the document is not released on time. The Importer Security Filing (ISF), commonly known as the “10+2” initiative, is a U.S. Customs and Border Protection (CBP) regulation that requires importers and vessel operating carriers to provide advance shipment information to CBP for U.S.-bound ocean cargo.
How to optimally manage FOB costs?
The more inventory orders company issues, the more costs due to paying to a 3rd party it occurs. This includes labor, order placement, shipping goods and insurance costs. Enough working capital is not always available and bank loans are not always an option. This is where Purchase Order financing steps in. POF is a commercial funding solution that provides an upfront payment to suppliers on behalf of clients for the verification of purchase orders.
In fact, financing in-transit inventory is usually in line with the use of documentary letters of credit. You can also refer to this as LCs. The letter of credit is a document supporting the commitment of a financial corporation to pay a determined amount of money to an exporting company once evidence of inventory’s shipment is provided. LCs ensure to both the importer and the exporter that payment is to happen if, and only if, the LC agreed terms are met. Once payment of LC is complete, the financial institution who initially gave a grant to the Letter of credit will receive payment from the importing company.
When operating an in-transit inventory, an insurance policy should be in force and the lender should be the lender loss payee.
Thus, after the fulfillment and payment of orders, the factor deducts its fees before remitting the remaining balance to his client. This way, you get enough working capital to fulfill larger orders along with benefiting from the factor’s fulfillment and logistics expertise. Besides, you also benefit from the factor’s insurance assistance as when operating an in-transit inventory, an insurance policy should be in force. Usually, the lender should be the lender loss payee.
What are FOB advantages?
When shipping FOB, you have total control over your freight costs. You can hire your own forwarder. Additionally, you can define a freight rate allowing you to get timely information from your forwarder which facilitates solving any transit issues. Transparency on shipping movements is also a big advantage. This is because you usually have a local contact to whom you can provide shipping information, quoted freight, and local costs.
Shipping with a FOB agreement allows you to be in control of your shipment. It puts you in a good position. Especially because you can choose the method of shipment, your own agents, a convenient insurance policy and set your own transit timing. You also can choose your own logistic partner who will work with you and serve your best interest.
What are FOB disadvantages?
A common issue when choosing FOB is the potential complication of the supplier. Especially those refusing to cooperate with the shipping company of your choice. Also to work with another consignee than their own freight forwarder. Other FOB disadvantages are as follows:
- Shipper must arrange the export permits
- The Shipper must pay the custom clearance and the terminal handling charge
- Shipper cannot recover any loss when the merchandise is already on the vessel
- A seller cannot recover the price if the buyer fails to nominate a suitable vessel which leads to a future price drop
- Walmart is much better at shipping then you are
- Walmart will buy the goods FOB China. No insurance and shipping risk to you. Also, faster and cheaper funding options for you.
Although FOB requires extra effort on your part, it leads to a lower risk as you will have a clear picture of all expenses. In fact, you can avoid many problems such as delays and unexpected additional fee are avoided with good FOB planning.
When exporting from countries such as China, FOB China to your large client is your best choice for an optimal export deal. You can utilize invoice factoring with CAD or a Vendor Guarantee. As compared to the much more costly and risky purchase order financing of goods from China FOB your client’s warehouse.