FOB is widely used incoterm in sea shipments.
The cost per unit under this incoterm is known as FOB price.
FOB price is used for calculation of CIF & CFR price, let's understand with
simple equations:
FOB price + Freight value = CFR price
FOB price + Freight value + Insurance value = CIF price
At the time of negotiation seller gives quotation as per
buyer's requirement. Let's assume buyer asked quotation for CFR price, seller
gave the quotation accordingly. But buyer found the price little high, so they
requested for revised quotation with FOB price and received the same. Now buyer
will compare both quotes and will try to find out hidden Freight cost in CFR
price.
Let's assume the commodity is parboiled rice and seller
quoted $800 per metric ton with CFR delivery term.
POL: Nhava Sheva port, India
POD: Cotonou port, Benin
In this case delivery term will be mentioned in contract:
CFR Cotonou.
But after buyer's request they changed the quotation, and
the new price is $720 per metric ton which is FOB price.
In this case delivery term will be mentioned in contract:
FOB Nhava Sheva.
So here we saw $80 ($800-$720) per metric ton is reduced
when incoterm is changed from CFR to FOB. This $80 can be considered as Freight
cost.
Now buyer needs to calculate total freight cost for the goods to be exported.
Let's assume total quantity of rice is 25 metric ton, so total freight cost as per seller's quotation will be 25×$80=$2000.
Now buyer will approach local carrier/vessel agents in Benin and will ask them to share quotation for ocean freight charges from Nhava Sheva, India to Cotonou, Benin. Let's assume they received quotation of $1700 for 25 metric tons of rice as lowest ocean freight.
In this case buyer can save $300 overall if they arrange the
transportation and execute this deal under FOB term.
How ?
CFR price was $800 per metric ton, so cost of 25 metric ton
will be $20000 (25×$800).
But if they choose FOB, then the total cost will be $18000
(25×$720), and ocean freight is $1700, so total cost will be $19700
($18000+$1700).
Total saving: $20000-$19700= $300.
(The same calculation is applicable for insurance amounts in
case of CIF terms)
So as per above example if buyer and seller agree for FOB incoterms, buyer places purchase order and FOB contract gets finalize for an international trade of any commodity.
Once deal is seized seller starts the production and after
finished goods are ready they pass the information to buyer, in some cases
latest cargo readiness date is finalize at time of contract finalization and
seller make the goods ready by the agreed date.
Once goods are manufactured, seller packs the goods as per
agreement.
Meanwhile buyer approaches to vessel agents or owner for booking. Once space is booked buyer sends booking and contact details of local vessel agent (who operates on behalf of vessel owner at country of origin) to seller and seller approaches the agent at place of loading, once loading date is fixed, seller send goods to loading point, goods get loaded into the vessel and custom clearance happens at the port on seller's cost.
Seller sends all shipping documents to buyer as per agreed payment term after onboarding.
From this point seller's responsibilities ceases and buyer's
responsibility starts. Buyer approaches insurance company to insure the cargo
(marine transit insurance) and arrange custom clearance once vessel arrives at
port of destination.
This is the complete process of a shipment under FOB incoterm.
Note: FOB term is not recommended for containerized cargo.
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