Avoid Costly Shipping Mistakes: These 2 FOB Designations Can Impact Your Bottom Line
If you are interested in working within the transportation and shipping industry, in finance and accounting, or are responsible for any inventory, it’s a good idea to familiarize yourself with at least a few key industry-related terms. We’ll start with one of the most used terms in shipping and receiving: FOB. You’ll learn what FOB means, how it is used, where you can expect to see it, and how it can impact a company’s cost-saving strategies and bottom line.
You might be surprised to learn how many costs are associated with getting a package from a seller to a buyer, particularly in large commercial transactions. There are loading and unloading costs, insurance costs, and transport costs, such as fuel, and even transport vehicle maintenance, to name a few.
What are FOB Designations?
The acronym, “FOB”, stands for Free on Board and indicates who is responsible for the cost of shipping the package and who is responsible for any damages that may occur in transit.
FOB designations always include a city name. For example: “FOB, Orlando”. The city name indicates where the seller’s responsibility for the shipment ends and refers to either the Destination point or the Shipping Point.
There are two types of FOB designations:
1. FOB Destination
This FOB designation holds the seller responsible for the cost of shipping as well as any costs resulting from damages.
2. FOB Shipping Point
This designation relieves the seller of responsibility for the package once the goods leave the point of origin. The buyer is then responsible for both the cost of shipping as well as any damages to the item. For this reason, a buyer may purchase insurance on the items being transported.
FOB Destination Subtypes
The FOB Destination designation is further broken down into three subtypes. Since these are designated FOB Destination, the seller will assume all risks until the shipment reaches the destination. The subtypes clarify who is responsible for the cost and how that cost is invoiced.
1. FOB Prepaid and Allowed
When you see this designation, it means that the seller owns and pays for the transport of the items. The seller assumes all risks until the package is delivered to the buyer.
2. FOB Prepaid and Added
Under this designation, the seller bills the costs of transport to the buyer. This could be noted on an invoice as a shipping charge. The seller still assumes all the risk until the item is delivered to the buyer.
3. FOB Freight Collect
Here the buyer must pay the cost of transport by deducting the cost from the seller’s invoice. The seller is still responsible for the goods until they are delivered to the buyer.
The two types of FOB designations, FOB Destination and FOB Shipping Point, show us who holds the responsibility for damages and is based on where the package is located when the damage occurs.
If the package is designated FOB Destination the seller will be responsible for damages to the shipment until the package reaches the buyer. If the shipment is designated FOB Shipping Point, the seller’s responsibility for damages ends once the package leaves the point of origin. The buyer is then considered the owner of the items being shipped, and if the package becomes damaged after leaving the point of origin, the buyer will absorb any costs related to damages during transport.
Essentially, the FOB Shipping Point designation benefits the seller, while the FOB Destination designation is to the advantage of the buyer.
Why are FOB Designations Important?
FOB Designations are important for accounting purposes. These designations determine when the seller can record the sale, and when the buyer can add the items to their inventory.
A seller who records the sale of items included in a shipment designated FOB Destination before the items reach their destination puts himself at risk. It is possible that the items may be damaged before reaching the buyer or may not reach the destination at all.
Imagine if the item was lost or damaged. The seller would then have a sale recorded and counted as revenue and profit, when in fact, it will be a loss since the seller will need to pay the costs to replace the item. This would not be a concern if the package is designated FOB Shipping Point since the buyer cannot hold the seller responsible for the missing or damaged item.
On the buyer’s side, inventory costs include all costs to prepare the inventory for sale, including shipping costs, such as insurance or replacement of lost or damaged items.
Suppose an employee mistakenly adds an item designated FOB Shipping Point to the buyer’s company inventory prior to receiving the item. A salesperson, seeing the item in inventory then agrees to sell the item to a customer, only to discover later that the item had not arrived. The buyer would take the loss here since they would need to purchase a replacement item and would have no claim against the seller. If the shipment in this scenario is designated FOB Destination, the buyer could submit a claim to have the seller replace the item at the seller’s own expense.
Understanding these terms correctly is vital to a company’s bottom line.
Since the FOB designations govern costs associated with liability and inventory costs, they have a major impact on a company’s balance sheet and bottom line. Misunderstanding or misuse of this and other terms can potentially damage or even destroy a business. Likewise, understanding FOB designations can impact a company’s cost savings strategies, for better or worse.
Issues with FOB Designations: International vs. Domestic
Incoterms are international trade terms that are published by the International Chamber of Commerce (ICC). These terms govern international shipments. However, companies shipping within the United States must also adhere to the Uniform Commercial Code (UCC). Since the legal definition of FOB designations and classifications may vary from country to country, shipping contracts must specify which set of laws are applicable to the contract.
How You Can Apply This Information
Any company that purchases or sells products is potentially impacted by FOB Designations. Investing some time into learning and fully understanding FOB designations, as well as other terms used in the transportation and shipping industry can give you a competitive edge in today’s job market. On the job, this knowledge can help you to stand out and be seen as a conscientious and knowledgeable employee. Similarly, business owners who understand these terms can make better-informed decisions around shipping and inventory that positively impact their company’s profits.
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