Free On Board (FOB)

Definition

Free On Board (FOB) is a term used in international trade to specify at which point the seller’s responsibilities, including cost and risk of transport, are transferred to the buyer. Under FOB shipping terms, the seller is responsible for all costs and risks up until the goods are loaded on board the shipping vessel. From that point on, the buyer assumes all responsibility for the goods.

Phonetic

The phonetics of the keyword: Free On Board (FOB) is /friː ɑn bɔːrd/.

Key Takeaways

1. Definition: Free On Board (FOB) is a shipping term used in international trade, indicating who is responsible for the shipment of goods at what point during the delivery process. The party designated as FOB is responsible for the costs and risks associated with the transportation.
2. Two Types: There are two types of FOB – FOB destination and FOB shipping point. In FOB destination, the seller retains the responsibility and costs of transportation until the goods reach the buyer’s location. On the other hand, with FOB shipping point, the buyer takes on the responsibility and costs of shipping when the goods leave the seller’s premises.
3. Risk and Ownership Transfer: FOB also determines when the ownership and risk of the goods transfers from the seller to the buyer. For FOB destination, ownership transfers when the goods are received by the buyer, and for FOB shipping point, ownership transfers when the goods are shipped by the seller.

Importance

The business/finance term Free On Board (FOB) is important because it is a crucial part of trade agreements and contracts, identifying the point at which the costs and risks associated with shipping goods shift from the seller to the buyer. By stipulating that goods are FOB, the seller is responsible for the condition, cost, and delivery of goods to a specific location, usually a shipping port. After the goods are ‘free on board’ , liability and costs transfer to the buyer, who is responsible for insurance, transportation, and risks of damage or loss. Underscoring the terms and conditions of shipping transactions, FOB also affects the accounting of such transactions, helping to avoid disputes around the timing of revenue or expense recognition. Thus, FOB plays a vital role in international trade, logistics, accounting, and risk management.

Explanation

The primary purpose of Free on Board (FOB), a term used in international trade, is to set clear guidelines for the division of shipping obligations, costs, and risk between the seller and buyer of goods. The term identifies when the responsibility and risk of goods is transferred from the sellers to the buyers. This is an essential component of international trade as it prevents disagreements between the two parties involved regarding who is responsible for paying the costs associated with shipping, transportation, insurance, and other related expenses.FOB is frequently used in contracts for the sale and purchase of tangible goods to determine when the risk of loss shifts from the seller to the buyer. For example, if a contract stipulates “FOB destination,” it means the seller retains risk and costs until the goods are received at the buyer’s location. Conversely, “FOB shipping point” or “FOB origin” indicates that the buyer takes over risk and costs of transportation as soon as the goods leave the seller’s location. Therefore, FOB plays a critical role in establishing a transparent and fair allocation of costs and risks between the seller and the buyer in global trade transactions.

Examples

1. Electronics Manufacturing: Assume a U.S. electronics company orders parts from a Japanese company, and the agreed terms are FOB at the Japanese company’s warehouse. This means the responsibility and risk of transporting these goods across international lines falls on the U.S. company once they leave the Japanese warehouse. From loading the goods onto a truck, ensuring they safely arrive at the port, get loaded onto a ship and finally make it to the U.S., all liability lies with the buyer.2. Wine Importing: Let’s take a wine retailer in New York importing wines from a vineyard in France with FOB terms from the French vineyard. It simply means the French vineyard would cover the costs of transportation of the wine to the nearest port, including all the legalities and paper work within France. Once the wine reaches the port and is loaded on the ship, the New York retailer takes up the costs from there.3. Raw Materials for Furniture: A furniture manufacturer in Canada buys lumber from a US supplier. If the agreed upon terms are FOB at the supplier’s sawmill, once the lumber is loaded onto the shipping vehicle at the sawmill, the Canadian manufacturer takes on the responsibility. It must be ensured the goods arrive safely at their factory including dealing with the customs at the Canada-US border. If any damage occurs during transit or there are issues at customs, the Canadian company bears that risk.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Shipping Terms
• Freight Collect
• Destination Charges
• Carrier Risk
• Cost, Insurance and Freight (CIF)

Sources for More Information

• Investopedia
• The Balance Small Business
• Corporate Finance Institute
• Shipping Solutions