International Trade (Intl Trade) 101: Introduction to International Trade - What is International Trade Definition, Importance Benefits Trade as of GDP

What This Is

International trade is the exchange of goods and services between countries. It involves the buying and selling of products across borders, often involving different currencies, languages, and regulations. For example, a US importer buys a shipment of electronics from a Chinese exporter. The exporter ships the goods from Shanghai to Los Angeles, and the importer pays for the goods using a letter of credit (LC). However, the importer discovers that the exporter has included incorrect documents, leading to a delay in payment.

Key Terms & Rules

• Incoterms (International Commercial Terms): Standardized terms for trade transactions, defining responsibilities and risks for buyers and sellers.
• EXW (Ex Works): Buyer bears all costs and risks from seller’s premises – most seller-friendly Incoterm.
• FOB (Free on Board): Buyer bears costs and risks from the point of loading on the vessel – commonly used for sea freight.
• CIF (Cost, Insurance, and Freight): Seller bears costs and risks until the goods are delivered to the buyer's destination – includes insurance.
• UCP 600 (Uniform Customs and Practice for Documentary Credits): Governs LC transactions globally, ensuring compliance and security.
• URC 522 (Uniform Rules for Collections): Regulates collections and cash payments, providing a standardized framework for international transactions.
• HS (Harmonized System) Codes: International classification system for goods, used for customs clearance and trade statistics.
• Duty Calculation Formula: Duty = (HS Code Value x Tariff Rate) / 100
• Letter of Credit (LC): A payment guarantee issued by a bank, ensuring payment to the seller upon presentation of compliant documents.
• Confirmed LC: A confirmed LC is guaranteed by the buyer's bank, providing additional security for the seller.
• Unconfirmed LC: An unconfirmed LC is not guaranteed by the buyer's bank, leaving the seller with higher risks.

Step-by-Step Process

1. Classify Goods using HS Codes: Determine the HS Code for the goods being traded, ensuring accurate classification and compliance with customs regulations.
2. Apply Incoterms: Choose the correct Incoterm for the transaction, defining responsibilities and risks for the buyer and seller.
3. Establish a Payment Method: Decide on a payment method, such as a letter of credit, open account, or cash in advance.
4. Issue a Commercial Invoice: Prepare a commercial invoice, including the HS Code, Incoterm, and payment terms.
5. Open a Letter of Credit: Open a letter of credit, specifying the payment terms, documents required, and any additional conditions.
6. Clear Customs: Clear customs, ensuring compliance with regulations and payment of duties and taxes.

Common Mistakes

• Mistake: Confusing CIF and CIP.
• Correction: CIF includes insurance, while CIP does not. Example: A seller ships goods CIF, but the buyer discovers that the goods are damaged during transit. The seller is liable for the damage, as CIF includes insurance.
• Mistake: Assuming “open account” is risk-free.
• Correction: Open account transactions involve higher risks for the seller, as the buyer may not pay on time or at all. Example: A seller ships goods on open account, but the buyer delays payment, causing cash flow problems for the seller.
• Mistake: Misusing “free on board” with air freight.
• Correction: FOB is typically used for sea freight, while for air freight, the correct term is “free at airport” (FAA) or “free at carrier” (FAC). Example: A seller ships goods FOB, but the buyer discovers that the goods were damaged during air transit. The seller is liable for the damage, as FOB includes responsibility for the goods until they are delivered to the buyer.

Exam / Certification Tips

• FOB vs FCA: FOB transfers risk when the goods are on board the vessel, while FCA transfers risk when the goods are delivered to the carrier.
• Confirmed vs Unconfirmed LC: A confirmed LC is guaranteed by the buyer's bank, providing additional security for the seller.
• DPU (Destination Port Unloaded) vs DAT (Destination Arrival Terminal): DPU transfers risk when the goods are unloaded at the destination port, while DAT transfers risk when the goods arrive at the destination terminal.

Quick Practice Scenario

A Chinese exporter sells goods FOB Shanghai to a US importer. Who bears the risk of loss or damage during sea transit?

Answer: The buyer bears the risk of loss or damage during sea transit, as FOB transfers risk when the goods are on board the vessel.

Last-Minute Cram Sheet

• Incoterms define responsibilities and risks for buyers and sellers.
• EXW: Buyer bears all costs and risks from seller’s premises.
• FOB: Buyer bears costs and risks from the point of loading on the vessel.
• CIF: Seller bears costs and risks until the goods are delivered to the buyer's destination, including insurance.
• UCP 600 governs LC transactions globally.
• URC 522 regulates collections and cash payments.
• HS Codes classify goods for customs clearance and trade statistics.
• Duty = (HS Code Value x Tariff Rate) / 100
• Letter of Credit (LC): A payment guarantee issued by a bank.
• Confirmed LC: Guaranteed by the buyer's bank, providing additional security for the seller.
• Unconfirmed LC: Not guaranteed by the buyer's bank, leaving the seller with higher risks.
• Under FOB, risk transfers when goods are on board the vessel – not at the port gate or on the dock.
• CIF includes insurance, while CIP does not.
• Open account transactions involve higher risks for the seller.