The Bakery's Second Site Decision
Riverside Bakery has traded profitably for nine years from a single high-street unit, turning over £620,000 last year with a net margin of 7%. Demand regularly exceeds capacity: the owner turns away wholesale enquiries most weeks and Saturday queues stretch onto the pavement. A unit on an out-of-town retail park is available at £48,000 annual rent, roughly double the current site. Fitting it out would cost £95,000, funded by a bank loan at 9% over five years. The owner's accountant warns that wholesale customers demand 45-day payment terms, while ingredient suppliers currently require payment within 14 days. The owner has £30,000 in retained reserves and no experience of managing two sites. Staff recruitment in the area is difficult, and the owner currently works 60-hour weeks.
1. Assess whether Riverside Bakery should open the second site. Recommend and justify a decision.
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Framework: capability vs. opportunity.
Case for expansion:
- Unmet demand is the strongest signal - turning away wholesale enquiries represents lost revenue that the current site cannot capture.
- Nine years of profit and a 7% net margin (£43,400) demonstrate operational competence.
- The loan is affordable in principle: £95,000 at 9% over five years is roughly £1,970 per month, about £23,600 annually.
Case against (or for delay):
- Working capital gap. Wholesale customers pay in 45 days but suppliers demand payment in 14 days - a 31-day funding gap on every order. With only £30,000 in reserves already committed to the loan, a single large wholesale order could exhaust cash.
- Management stretch. The owner already works 60 hours a week on one site. Two sites with scarce staff is a recipe for quality failure at the flagship.
- Cost doubling. Rent doubles and fixed costs rise before wholesale revenue arrives.
Judgement: The demand evidence is strong, but the cash-conversion cycle and management capacity are the binding constraints, not demand. A defensible recommendation is a staged entry: secure one or two wholesale contracts first, negotiate supplier terms toward 30 days, and recruit a site manager before committing to the lease. Immediate expansion risks insolvency through a cash gap even while profitable on paper. A strong answer names the trade-off explicitly: growth is constrained by liquidity and leadership bandwidth, not by customers.
2. The owner proposes funding the fit-out entirely from the £30,000 reserves instead of borrowing. Evaluate this idea.
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What it solves: avoids £23,600 of interest and principal payments, improving monthly cash flow.
What it breaks:
- £30,000 is less than a third of the £95,000 fit-out cost - the proposal is not actually feasible without additional funding.
- Reserves are the business's buffer against exactly the risk this expansion creates (the 31-day wholesale payment gap). Spending them removes the safety net at the moment risk peaks.
- Depleting reserves may breach any overdraft or supplier confidence assumptions.
Judgement: Using reserves as part funding (say £20,000) alongside a smaller loan can reduce interest while preserving a buffer. Using them entirely is both infeasible and imprudent. The answer should distinguish between the cost of borrowing and the cost of illiquidity - the latter is usually higher for a small firm.