Revised 1st Class question

Question – 1 (C is cost, P is price, G is gross, FOB is freight / free on board)

Free on Board – Free is a misnomer. Nothing is free. It simply means that importer is not going to come to exporter’s country to get the goods from factory to be loaded (boarded) on the ship. FOB (Cost) means all the cost of good till it gets boarded on the ship in exporter’s country. FOB (Price) equals FOB (Cost) + Margin added by the exporter. This is called Gross FOB (Price). The agent’s commission is included in it. If the agent’s commission is removed from the Gross FOB (Price), one arrives at Net FOB (Price).

· Gross FOB (Price) = FOB (Cost) + Margin added by exporter

· Net FOB (Price) = Gross FOB (Price) – Agent’s Commission

On what basis, the agent’s commission is calculated –

· Agent’s commission is NOT calculated as a % of Gross FOB (Cost), else agent will calculate the cost incurred to exporter, which no exporter / manufacturer discloses ever. Hence, agent’s commission is calculated as a % of Gross FOB (Price).

· Agent’s commission is NOT calculated as a % of CIF (Price) as exporter is not making money in freight and insurance. So, why pay a % to agent when Insurance and Freight can earn nothing to exporter (they are always at actual).

Scenario – If Gross FOB (Price) is INR 100 and agent’s commission is 5%, then money coming into exporter’s country is 100 - 5%*100 = INR 95 [which is Net FOB (Price)]. The government of Exporter will hence earn Net FOB (Price) as agent will be given commission and after that the money comes to exporter’s country.

Incentive – Incentive is given by the government of Exporter’s country. It is earned on what I have earned for the nation, which is Net FOB (Price), INR 95 (as above example).

CIF – It stands for Carriage, Insurance premium, Freight. C is a misnomer and it actually stands for Gross FOB (Price). Freight and Insurance premium is always calculated on actual as importer can verify the charges for the same by looking at the bills of freight and insurance. So, exporter can’t make money on them (Freight and Insurance are at actual). Hence, exporter makes money on Gross FOB (Price) only by adding his margin in it.

Freight / Cargo – It is the cost of transportation of goods (per tonne of goods transported) generally for commercial gain by ship, truck, vans or train.

Agent’s role – The exporter doesn’t have an office in importer’s country. So, he hires an agent, who represents him there, helps show the importer samples of exporter’s product to win the export order. The agent is signed well before an order is received (or not received).

1. Ex Factory Cost = INR 1,30,000 (Excluding Marketing Cost); Ex Factory cost is the cost up to the gates of the factory

2. Export Marketing Cost (Cost of marketing incurred in international location where product is to be shipped) = INR 30,000 (Here, marketing is done by the exporter to make him known to probable importers in different countries)

3. Transportation cost up to on board the ship = Rs 40,000

4. All costs up to on board the ship is called FOB (C)

5. Assume a profit of 25% of FOB (C)

6. Net FOB (P) = FOB (C) + Profit – Incentives (given by exporter’s government to exporter)

7. Incentives = 10%

8. Incentives are calculated as a % of Net FOB (P)

9. Agents commission = 5% & is calculated as a % of G FOB (P)

10. G FOB (P) – Agent’s Commission = Net FOB (P)

11. Freight = INR 10,000

12. Insurance Premium = 10% of insured value and insured value is 110% of CIF (P)

13. CIF (P) = G FOB (P) + Insurance Premium + Freight

Calculate CIF (P)

Solution –

Let Net FOB (P) be X (Using Equation 6)

Then X + 0.10 X = (1,30,000 + 30,000 + 40,000) + 25% * (1,30,000 + 30,000 + 40,000)

X = 227272

Let Y = G FOB (P) (Using Equation 10)

Y – 0.05 Y = X

Y = 239234

Let Z = CIF (P) (Using Equation 13)

Z = Y + (1%) * (110%) * (Z)

Z = 252006