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What is currency adjustment factor (CAF) in international shipping?
CAF is an additional charge applied to freight rates to account for fluctuations in currency exchange rates. Learn how to calculate it and more about it in this blog.
The complexities of international shipping can seem challenging to even seasoned importers and exporters. Fluctuating exchange rates add another layer of uncertainty, potentially impacting profit margins and cost calculations. Navigating this intricate world of international shipping involves understanding various factors that can impact costs. One such element that plays a crucial role in determining the final price of shipping goods across borders is the Currency Adjustment Factor (CAF).
In this blog, we will delve into the intricacies of CAF and how it influences the logistics and supply chain management landscape.
In this blog, we will delve into the intricacies of CAF and how it influences the logistics and supply chain management landscape.
What is Currency Adjustment Factor (CAF)?
Currency adjustment factor is a term frequently encountered in the realm of international shipping. Simply put, it is an additional charge applied to freight rates to account for fluctuations in currency exchange rates. The international trade landscape is dynamic, with currency values constantly changing. CAF acts as a mechanism to mitigate risks associated with these fluctuations and ensures that shipping costs remain fair and reflective of prevailing market conditions.1
Currency Adjustment factor formula
To grasp the essence of CAF, it is essential to understand the formula governing its calculation. CAF is typically expressed as a percentage and is derived from the following formula:
Base Rate x 100
Here, the "Base Rate" represents the original freight rate, while the "Reference Rate" is the baseline exchange rate agreed upon by the parties involved. The resulting percentage represents the adjustment factor applied to the base rate to accommodate currency fluctuations.2
Base Rate x 100
Here, the "Base Rate" represents the original freight rate, while the "Reference Rate" is the baseline exchange rate agreed upon by the parties involved. The resulting percentage represents the adjustment factor applied to the base rate to accommodate currency fluctuations.2
How to calculate currency adjustment factor?
Calculating currency adjustment factor involves a straightforward process because of the aforementioned formula. It's worth noting that many shipping companies provide CAF values as part of their rate sheets, simplifying the process for shippers.
To calculate currency adjustment factor, follow these steps:3
To calculate currency adjustment factor, follow these steps:3
Step 1: Determine the reference rate
Identify the exchange rate at the time of quoting the freight charges. This is usually based on a specified currency, such as the US Dollar (USD).
Step 2: Identify the current rate
Determine the actual exchange rate applicable during the invoicing or payment period.
Step 3: Plug the values into the formula
Use the CAF formula to calculate the surcharge or discount percentage.
Step 4: Apply the CAF
Add or subtract the calculated CAF percentage to the quoted freight charges to adjust for currency fluctuations.
Example of currency adjustment factor
Suppose a company in India receives a freight quote for shipping goods to the US. The freight charges are quoted in US Dollars (USD) and the exchange rate at the time of the quote is $1 = INR 83.11. The company plans to ship the goods after a month.
However, due to currency fluctuations, when the company is ready to make the payment a month later, the exchange rate has changed to $1 = INR 78. In this scenario, the currency adjustment factor will come into play to adjust the freight charges based on the updated exchange rate. Let's calculate the CAF using the formula:
Base rate x 100
In this case:
Reference Rate (exchange rate at the time of quoting) = INR 83.11
Current Rate (actual exchange rate during invoicing) = INR 78
The calculated CAF is approximately 6.59%.
This positive value indicates an increase in the exchange rate, resulting in a surcharge on the quoted freight charges. Now, if the originally quoted freight charges were $10,000, we can calculate the adjusted charges using the CAF:
Adjusted charges = Quoted charges + (Quoted Charges \times CAF)
Adjusted charges = 10,000+(10,000 × 0.0659) = 10,659
The adjusted freight charges, considering the positive CAF, would be $10,659. This reflects the impact of the currency appreciation on the overall shipping costs.
In this example, the company incurs a surcharge due to the increase in the exchange rate underscoring how the currency adjustment factor plays a crucial role in adapting shipping costs to the ever-changing landscape of currency values in international trade.
This example is provided for illustrative purposes only and should not be construed as defining or encompassing the entirety of the concept.
However, due to currency fluctuations, when the company is ready to make the payment a month later, the exchange rate has changed to $1 = INR 78. In this scenario, the currency adjustment factor will come into play to adjust the freight charges based on the updated exchange rate. Let's calculate the CAF using the formula:
Base rate x 100
In this case:
Reference Rate (exchange rate at the time of quoting) = INR 83.11
Current Rate (actual exchange rate during invoicing) = INR 78
The calculated CAF is approximately 6.59%.
This positive value indicates an increase in the exchange rate, resulting in a surcharge on the quoted freight charges. Now, if the originally quoted freight charges were $10,000, we can calculate the adjusted charges using the CAF:
Adjusted charges = Quoted charges + (Quoted Charges \times CAF)
Adjusted charges = 10,000+(10,000 × 0.0659) = 10,659
The adjusted freight charges, considering the positive CAF, would be $10,659. This reflects the impact of the currency appreciation on the overall shipping costs.
In this example, the company incurs a surcharge due to the increase in the exchange rate underscoring how the currency adjustment factor plays a crucial role in adapting shipping costs to the ever-changing landscape of currency values in international trade.
This example is provided for illustrative purposes only and should not be construed as defining or encompassing the entirety of the concept.
Situations where currency adjustment factor is applicable
CAF is particularly relevant in international trade scenarios where currency exchange rate fluctuations are a common occurrence. It comes into play when dealing with contracts or agreements that involve multiple currencies. Shippers and carriers alike use CAF to ensure that the financial aspects of the shipping transaction remain equitable, even when currencies are subject to volatility. Essentially, CAF acts as a risk management tool, helping to stabilize freight rates and providing a degree of predictability in the ever-changing landscape of global commerce.
How to prevent currency adjustment factor surcharges?
While CAF is a standard practice in international shipping, there are strategies to minimize or even avoid CAF surcharges. One effective approach is to negotiate fixed or stable currency exchange rates as part of the shipping contract. By establishing a predetermined reference rate, both parties can mitigate the impact of currency fluctuations. Additionally, utilizing financial instruments such as forward contracts or currency hedges can provide a layer of protection against adverse currency movements, reducing the reliance on CAF adjustments. Furthermore, while it can bring unwelcome surprises, there are ways to navigate the situation by:
• Negotiate contracts with fixed prices: Opting for fixed freight rates in stable currency denominations can eliminate CAF uncertainties.
• Shorten contract periods: Consider shorter contracts to minimize exposure to potential exchange rate fluctuations.
• Hedge currency risks: Utilize financial instruments like forward contracts or options to lock in exchange rates and prevent CAF surprises.
• Choose carriers with transparent CAF policies: Seek clarity on the carrier's CAF calculation method and application before signing any contracts.
• Negotiate contracts with fixed prices: Opting for fixed freight rates in stable currency denominations can eliminate CAF uncertainties.
• Shorten contract periods: Consider shorter contracts to minimize exposure to potential exchange rate fluctuations.
• Hedge currency risks: Utilize financial instruments like forward contracts or options to lock in exchange rates and prevent CAF surprises.
• Choose carriers with transparent CAF policies: Seek clarity on the carrier's CAF calculation method and application before signing any contracts.
CAF in supply chain management
In the broader context of supply chain management, understanding and effectively managing CAF is crucial. Supply chain management involves a multitude of interconnected processes, and any disruption in these processes can have a cascading effect on the entire operation. CAF becomes particularly relevant in international supply chains, where currencies fluctuate, posing financial challenges for both buyers and sellers. Supply chain professionals need to consider currency fluctuations as part of their cost projections and risk management strategies. By incorporating CAF into logistics planning, companies can better anticipate and manage the financial aspects of international shipping, contributing to more accurate budgeting and streamlined operations.
Situations where CAF is applied
The currency adjustment factor typically comes into play in the following situations:
Ocean freight shipments:
As mentioned earlier, CAF is most commonly applied to ocean freight shipments, particularly between regions with volatile exchange rates.
Long contract periods:
In cases where contracts span months or even years, protecting against unpredictable currency fluctuations becomes crucial. This is where CAF offers a buffer for carriers.
Specific trade routes:
Certain trade routes, especially those involving currencies prone to large swings, may have standardized CAF clauses incorporated into shipping contracts
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Frequently Asked Questions
What is CAF on invoice?
CAF on an invoice stands for Currency Adjustment Factor. It is a surcharge or adjustment applied to the total cost mentioned on an invoice in the context of international shipping. The purpose of the CAF on an invoice is to account for fluctuations in currency exchange rates that may have occurred between the time of quoting the price and the actual payment. This adjustment ensures that the invoiced amount accurately reflects the current market value of the involved currencies, providing a fair and transparent representation of the costs incurred during the international shipping process.
What is CAF code?
The CAF code refers to a specific identifier or reference associated with the currency adjustment factor in the shipping industry. This code is often used for documentation and tracking purposes, allowing stakeholders to easily identify and manage the application of CAF in various transactions. The CAF code helps streamline communication and record-keeping within the supply chain and logistics sector, ensuring that both shippers and carriers can efficiently manage and reference the Currency Adjustment Factor in their documentation. It plays a crucial role in maintaining clarity and accuracy in financial transactions related to international shipping.
Published on January 8, 2024.
Sources:
1. https://www.investopedia.com/terms/What Is the Currency Adjustment Factor (CAF)
2. https://www.dhl.com/pl-en/home/freight/help-center-for-european-road-and-rail/currency-adjustment-factor.html
3. https://en.wikipedia.org/wiki/Currency_adjustment_factor
4. https://www.dripcapital.com/en-in/resources/blog/currency-adjustment-factor-caf
5. https://www.bluedart.com/currency-adjustment-factor
Sources:
1. https://www.investopedia.com/terms/What Is the Currency Adjustment Factor (CAF)
2. https://www.dhl.com/pl-en/home/freight/help-center-for-european-road-and-rail/currency-adjustment-factor.html
3. https://en.wikipedia.org/wiki/Currency_adjustment_factor
4. https://www.dripcapital.com/en-in/resources/blog/currency-adjustment-factor-caf
5. https://www.bluedart.com/currency-adjustment-factor
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*Map not to scale. The map has been used for design and representational purpose only, it does not depict the geographical boundaries of the country. These do not conform to the external boundaries of India recognized by the Survey of India.
*Map not to scale. The map has been used for design and representational purpose only, it does not depict the geographical boundaries of the country. These do not conform to the external boundaries of India recognized by the Survey of India.
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