Free on board (FOB)
Free on board (FOB) definition
Free on board (FOB) is a shipping term that indicates whether the seller or buyer will be responsible for ensuring that goods are safely loaded onto a vessel at the port of shipment.
Free on board (FOB), also referred to as freight on board, is a commercial shipping term used in overseas transport and on inland waterways. The FOB designation is followed by a port name, which indicates where the liabilities for transporting the goods change hands from seller to buyer.
FOB origin, or FOB shipping, means the buyer takes responsibility at the point of origin of the freight. FOB destination means that the buyer only takes responsibility for freight once it reaches its destination, and the seller is liable for any damage.
While FOB traces its history to the shipping industry, it is now also widely used in North American overland shipping by truck.
Let’s look at how this works. Say, for instance, you’re a manufacturer exporting goods FOB Vancouver. As a seller, you would be responsible for any damage or loss of goods, as well as transportation costs, all the way to the port of Vancouver. Once the goods are loaded onto the ship, the responsibility for loss and damage, as well as for shipping costs, shifts to your buyer.
It’s important to note that there’s no change of ownership as result of the FOB agreement. The terms of ownership are set by the bill of sale or any other contract the buyer and seller have signed.
“Sometimes, people get into the habit of using FOB indiscriminately,” says William Polushin, a Senior Business Advisor with BDC Advisory Services. “Often the buyer and seller may have different concepts of what FOB means. You have to clarify and confirm in writing which terms you’re using.”
International trade terms and FOB
As in any contract, the buyer and seller need to have the same definitions of key terms. In a situation where the parties work in different countries with varying laws, they need to identify which governing rules apply to the contract.
The most commonly used international trade terms are published by the International Chamber of Commerce (ICC). Called Incoterms, an acronym for “international commercial terms,” they offer trading partners universal terms, and clarity and consistency, on risk and liability.
To indicate the use of Incoterms, your shipping documents should read, “FOB Name-of-Port (Incoterms 2020).” The year refers to the latest edition of the Incoterms.
Who pays the freight?
Jean-François Laurin, a BDC consultant who specializes in international logistics and compliance, advises entrepreneurs to get a clear picture of the total costs involved in the FOB terms.
For example, if you’re buying machine parts FOB Hamburg (Germany), you’ll be paying for the carriage (i.e., transport over water) and related shipping costs. In a volatile market, you could be on the hook for unforeseen changes in the cost of transport.
On the other hand, if your seller ships the machine parts FOB destination, freight prepaid, they will be taking on shipping costs.
Freight payment terms sometimes follow the FOB designation to designate who will be responsible for shipping costs:
- freight prepaid—the seller will pay all costs for shipping
- freight collect—the buyer will pay all costs for shipping
If no freight-payment terms follow the FOB designation, then the costs and risks of shipping are transferred from seller to buyer at the named port.
Common FOB terms with freight payment terms
|FOB origin, freight prepaid||The seller bears all the costs of shipping, while the buyer takes on the risk of the goods at the shipping point (or point of origin)|
|FOB origin, freight collect||The buyer is responsible for everything, including freight and shipping costs, as well as liability for the cargo.|
|FOB destination, freight prepaid||The seller pays all shipping costs|
|FOB destination, freight collect||The buyer pays the freight charges when the goods arrive on his or her loading dock|
What is the FOB price?
An FOB quote includes the costs of the following:
- the actual goods (including the seller’s profit)
- commercial and export documentation, and customs formalities
- loading, as well as transport from the seller’s location to the FOB port
- any pre-shipment inspection
- loading of the ship
- taxes and export fees
See if it makes sense to get help from freight forwarders, third-party logistics or other supply chain experts. It may cost a little more, but it sure takes a lot of the uncertainty and confusion out of the equation.
FOB shipping vs. FOB destination
FOB shipping (origin) means the buyer takes responsibility for freight at the point of origin. FOB destination means they only take responsibility once the freight reaches its destination.
The difference in cost between FOB shipping and FOB destination lies in the time it takes to deliver, the liabilities for potential damages and shipping costs.
“Often, you’ll see entrepreneurs opt for FOB shipping, almost by default,” says Ali Lajevardi, Senior Managing Advisor with BDC Advisory Services. “Seeing the range of prices between FOB shipping and FOB destination, they’re thinking, ‘The seller’s making money off me.’”
Negotiating FOB shipping terms will often lead businesses to try and do everything themselves, explains Lajevardi. This can lead to costly mistakes that eliminate any potential savings or end up costing more. Oftentimes, the resources devoted to figuring out import and export issues could be better used by focusing on their core business.
He advises entrepreneurs to keep an open mind when considering FOB options. “See if it makes sense to get help from freight forwarders, third-party logistics or other supply chain experts. It may cost a little more, but it sure takes a lot of the uncertainty and confusion out of the equation.”
How will customers perceive the FOB terms?
When deciding on FOB terms, a business also needs to think strategically and ask how customers will perceive them and their pricing.
“The more headaches your buyer has,” Polushin says, “the less likely they'll buy from you. So, you want to eliminate the international border in the buyer’s mind. Take responsibility for the insurance, carriage and customs, and get the goods to their door, especially if you are exporting to the U.S., because that’s what their American suppliers are doing.”
What is FOB and CIF?
CIF stands for cost, insurance and freight. The abbreviation is widely used in overseas shipping and on inland waterways. In a CIF contract, the seller is responsible for costs, insurances and freight.
For instance, if you sign a deal that’s CIF Sydney, you’re paying for all the costs of shipping goods from your warehouse in Canada to Sydney. You’re also paying for the insurance and providing the documents needed for the buyer to get the goods from the ship.
It’s important to note, though, that in a CIF agreement, delivery is considered complete as soon as the product is loaded at the shipping point. At that time, the buyer becomes liable for any loss or damage.
Clarity, precision and solid documentation take time. You have to be ready to make the necessary effort.
What is the difference between FOB and FCA?
FCA stands for free carrier. In an FCA agreement, the seller is responsible for all the costs and risks of getting the goods to the named destination, on a specific date, at a specific loading dock.
Delivery is complete when the shipped goods are ready to be unloaded by the buyer or their representative. At that point, the buyer takes on all the risks of loss or damage to the goods.
For FCA, the seller’s responsibilities include:
- preparing the goods for export
- taking care of export formalities
- notifying the buyer once goods are delivered
- updating the buyer if the pick-up failed to take place within the specified time
For FCA, the buyer is responsible for:
- providing the seller with the contact information of the carrier to whom the goods should be delivered
- specifying the timing, mode of transport and location for the reception of the goods
- preparing the paperwork for the international transport, and other formalities
Keep your accountant up to date on FOB shipments
Your FOB terms affect your accounting.
The timing—when the goods ordered become an asset on your balance sheet—can have a significant impact if, for example, you buy or ship goods toward the end of a fiscal year.
Let’s say your fiscal year-end is June 30th and, on that date, you ship goods FOB destination. You keep that shipment as an asset at year-end because the goods are yours until the ship arrives at the destination.
On the other hand, if on June 30th, you ship goods FOB origin, those goods are no longer considered inventory; they become an asset in your buyer’s books that day.
How to answer your FOB-related questions
If import and export issues are going to be a significant part of your business, consider these three tips:
1. Assess the level of help you need
- How much can your staff help? Can you hire expertise?
- Can online sources such as government agencies (Export Development Canada, Canada Border Services Agency) meet some of your needs?
- Can a customs broker, freight forwarder or other logistics experts help?
- Is your business ready to dedicate the required time and effort?
“Clarity, precision and solid documentation take time,” says Polushin. “You have to be ready to make the necessary effort because it will seem like much more than you ever expected.”
2. Adopt a partnership mindset
Lajevardi advises entrepreneurs to have exploratory conversations with key players in your supply chain, just as you would with partners in your value chain.
Connect with a customs broker, freight forwarder or other expert. Find out what they can do to help. Do they have services that can help save costs or build up your supply chain resilience? How can you reciprocate and help them?
3. Get sound advice
Customs documentation and international buyer-seller contracts are all about precise details. If these are not properly addressed, they “end up costing you more than you expected,” says Polushin.
Learn how to create a market entry plan, identify new customers, and assess risks, costs and logistics for your global expansion by downloading our free guide for entrepreneurs: Growing in International Markets.