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  • Writer's picturePeak Frameworks Team

What is Freight on Board (FOB)? Origin vs. Destination

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What is Freight on Board (FOB)?

Freight on Board or FOB is a shipping term that defines when the buyer/seller becomes responsible for the shipment. FOB is an important concept in trade, as it indicates the conditions under which the buyer/seller is liable for the goods.

Historically, FOB was coined to standardize and simplify the responsibilities of buyers and sellers in international trade. It originated in maritime law, signifying the point where the seller's responsibilities end, and the buyer's begin.

Freight on Board

Role in Standardizing Trade

By ensuring that both parties are clear about their obligations, FOB and similar terms have played an instrumental role in fostering international commerce. A recent example of this would be Tesla's acquisition of Grohmann Engineering in Germany. For a U.S. company like Tesla, understanding terms like FOB is crucial when negotiating deals and supply contracts overseas.

FOB Explained

fob explained

Components of FOB

At its core, FOB has two main components:

  • The fact that the goods are "Free On Board," i.e., they're onboard the ship, train, or plane.

  • The designated location or port where this handover takes place.

Difference between FOB Origin and FOB Destination

  • FOB Origin: Title and responsibility of the transfer of the goods from the seller to the buyer as soon as they're loaded onto the transportation mode. For instance, when European automakers ship cars to the U.S., using FOB origin means their responsibility ends as soon as those cars are onboard.

  • FOB Destination: Responsibility shifts from the seller to the buyer when the goods reach their destination. A company like Amazon, when importing electronics from China, might prefer a FOB destination to maintain control over the goods for longer, ensuring they arrive in the desired condition.

FOB Destination
Source: Double Entry Bookkeeping

Impact on Cost Structure

Determining when the title of goods changes hands affects revenue recognition, insurance liabilities, and transportation costs. Consider a pharmaceutical giant like Pfizer, which imports raw materials for its drugs. With FOB origin, any damage in transit becomes a buyer's concern, whereas, with FOB destination, the seller is responsible until the goods reach Pfizer's facilities.

FOB and Incoterms

The International Chamber of Commerce (ICC) introduced Incoterms to standardize international shipping and freight terms, eliminating ambiguities. FOB is just one of these terms, with others like CIF (Cost, Insurance, and Freight) or DDP (Delivery Duty Paid) offering alternative distributions of risks and costs.

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The Importance of FOB for Financial Professionals

Valuation Considerations

FOB can directly impact the valuation of goods. For an investment banker evaluating an M&A deal, understanding the FOB terms of the target company's imports can significantly influence the valuation. A misinterpretation could mean missing out on millions.

Risk Management

Awareness of FOB terms ensures that risks, especially in international transactions, are anticipated and managed. A 2015 situation with Volkswagen's diesel engines highlighted the importance of understanding product quality and liabilities when goods are in transit.

Contractual Implications

Negotiating with terms like FOB in mind can lead to more favorable deals. Whether it's an investment banker structuring a cross-border acquisition or a private equity professional assessing a company's supply chain, understanding FOB is essential.

Conclusion

In today's globalized business environment, understanding terms like FOB is non-negotiable for financial professionals. From changing the dynamics of a multi-billion-dollar deal to affecting a company's bottom line, its implications are vast and varied. By staying updated and flexible with international trade terms, professionals can not only mitigate risks but also identify new opportunities.

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