Contract Milking: Your Guide to Making the Transition

Are you considering making the leap to contract milking next season? This significant career move from employee to self-employed dairy farmer requires careful planning and preparation. Contract milking offers an excellent pathway into dairy farm ownership, but success depends on understanding the financial, legal, and practical aspects of the role.

Understanding Contract Milking

A contract milker operates as a self-employed dairy farmer who manages a farm operation while earning a share of the milk income. Unlike traditional employment, you’ll be responsible for covering designated expenses while having the opportunity to earn based on performance and milk production. This arrangement provides a stepping stone toward farm ownership while allowing you to develop essential business and farming skills.

Contract Negotiation: Getting the Fundamentals Right

The foundation of successful contract milking lies in thorough contract negotiation. Before signing any agreement, ensure you understand these critical elements:

Income Structure
Your income calculation method significantly impacts your financial planning. Will you receive a fixed dollar amount per kilogram of milk solids (kgMS), a percentage directly from the milk supplier, or a combination of both? Understanding this structure helps you forecast earnings and plan for seasonal variations in milk production.

Payment Timing
Dairy farming follows seasonal cash flow patterns. Determine when you’ll receive payments and whether you’ll need overdraft facilities to manage cash flow during lean periods. Most dairy operations experience higher income during peak production months, requiring careful financial management during the off-season.

Additional Income Streams
Explore whether you can generate additional revenue through activities like calf rearing allowances, grazing agreements, or other farm-related services. These supplementary income sources can improve your overall financial position.

Staffing Requirements
Calculate how many employees you’ll need and their associated costs. Consider seasonal variations in labor requirements, including calving, peak milking, and dry-off periods. Factor in wages, holiday pay, and compliance costs when budgeting for staff.

Learn more: Understanding PAYE: A Guide for New Zealand Employers

Operational Expenses
Clearly define which costs you’ll cover. Standard expenses typically include farm power (fuel, electricity), dairy shed consumables, insurance, ACC levies, and repairs and maintenance. Understanding these obligations prevents unexpected financial surprises.

Learn more: What expenses are tax-deductible in NZ?

Asset Requirements
Determine what equipment and assets you must provide. Consider whether you need to purchase these items outright or if leasing arrangements are available. This decision significantly impacts your initial capital requirements.

Learn more: Business Vehicle Finance: Lease or Buy?

Financial Planning and Cash Flow Management

Creating a comprehensive cash flow budget is crucial for contract milking success, particularly in your first year. This budget serves multiple purposes:

• Cash Flow Forecasting: Anticipate when money flows in and out of your business
• Profit Evaluation: Assess whether the opportunity meets your financial goals
• Decision Making: Determine if contract milking aligns with your personal and financial objectives
• Bank Relations: Demonstrate financial competence when seeking funding or overdraft facilities

Your budget should account for seasonal variations typical in dairy farming, with higher income during peak production and lower earnings during winter months.

Contract Milking – Tax Responsibilities

The transition from wages to self-employment brings significant tax implications. Unlike PAYE employment where tax is automatically deducted, you’re now responsible for managing your tax obligations directly.

Income Tax Management
Your tax situation becomes more complex as a contractor. In some cases, you may owe minimal income tax in your first year, but face a double tax bill in year two as you catch up with provisional tax payments. Early consultation with an accountant helps integrate tax planning into your cash flow management and explore options to smooth these payments.

GST Registration and Obligations
Understanding Goods and Services Tax (GST) is essential for contract milkers. GST applies to most goods and services at 15%. You must register for GST if your turnover reaches $60,000 in the past 12 months or is expected to reach this threshold in the next 12 months. Voluntary registration below this threshold may be beneficial.

As a GST-registered business, you’ll:

• Charge GST on milk and other farm income
• Pay collected GST to Inland Revenue
• Claim GST on most business expenses (excluding wages and bank financing costs)

This system can provide cash flow advantages when managed properly, as you can claim GST on significant purchases like equipment or feed.

Learn more: GST for New Zealand Businesses: A Comprehensive Guide

Business Structure Options

Choosing the right business structure impacts your tax obligations, liability exposure, and operational flexibility:

Sole Trader
The simplest structure where you operate as an individual. Easy to establish and manage, but offers no liability protection.

Partnership
Suitable when entering the arrangement with another person. Provides shared responsibility and resources but requires clear partnership agreements.

Company Structure
The most common choice for contract milking. Offers liability protection, potential tax advantages, and professional credibility. More complex to establish and maintain than sole trader arrangements.

Trust Structure
Less common for contract milking but may suit specific circumstances involving family arrangements or asset protection strategies.

Learn more: Choosing the right Business Structure

Technology and Systems

Modern contract milking requires efficient systems for financial management and compliance. Accounting software helps with:

• Cash flow budget preparation and monitoring
• Bank transaction coding and reconciliation
• GST return preparation and filing
• Financial reporting and analysis

Professional guidance ensures you choose software that suits your specific needs and integrates well with your operational requirements.

Learn more: Is Xero Right for My Business?

Building Strong Relationships

Success in contract milking extends beyond financial and operational considerations. The relationship with your farm owner is crucial for long-term success.

Due Diligence on Partners
Research your potential business partners thoroughly:

• Do their values align with yours?
• How effective has their communication been during negotiations?
• Can you work effectively with them long-term?
• What do references say about their business practices?

Contract Preparation
Ensure your contract includes all necessary clauses and protections. Standard templates from organizations like Federated Farmers provide good starting points, but professional review ensures the agreement suits your specific situation.

Communication Protocols
Establish clear communication channels and regular review processes. Successful contract milking relationships require ongoing dialogue about performance, challenges, and opportunities.

Setting Yourself Up for Success

Contract milking represents a significant career transition requiring thorough preparation:

1. Research Thoroughly: Understand the specific requirements and expectations of your potential role
2. Plan Financially: Create detailed budgets and secure appropriate funding arrangements
3. Seek Professional Advice: Engage accountants and lawyers familiar with agricultural contracting
4. Build Networks: Connect with other contract milkers and industry professionals
5. Develop Skills: Enhance your business management and financial literacy skills

The Path Forward

Contract milking offers an excellent opportunity to progress in the dairy industry while developing valuable business skills. However, success requires careful planning, thorough preparation, and professional support.

The transition from employee to self-employed contractor brings challenges and opportunities. Those who approach it systematically, with proper advice and planning, often find it a rewarding step toward eventual farm ownership.

Consider engaging experienced agricultural advisors who understand the unique aspects of dairy contracting. Their expertise can help navigate the complexities of contracts, taxation, and business structure, setting you up for long-term success.

The dairy industry continues to offer opportunities for motivated individuals willing to take calculated risks and work hard. Contract milking provides a proven pathway to develop the skills, experience, and financial foundation necessary for future farming success. With proper preparation and support, your contract milking venture can become the foundation for achieving your agricultural ambitions.

Remember, success in contract milking isn’t just about managing cows and milk production—it’s about running a successful business while building relationships that can last throughout your agricultural career.

If you would like any assistance with the tax side of your business, Business Like NZ Ltd would be happy to help. Contact our office to discuss.