The Internal
Audit
Chapter Six
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Chapter Objectives
1. Explain how the nature and role of chief marketing officer has changed.
2. Be able to work out breakeven analysis business problems.
3. Describe how to perform an internal strategic-management audit.
4. Discuss the Resource-Based View (RBV) in strategic management.
5. Discuss key interrelationships among the functional areas of business.
6. Identify the basic functions or activities that make up management, marketing,
finance/accounting production/operations, research and development, and
management information systems.
7. Explain how to determine and prioritize a firm’s internal strengths and weaknesses.
8. Explain the importance of financial ratio analysis.
9. Discuss the nature and role of management information systems in strategic
management.
10. Develop an Internal Factor Evaluation (IFE) Matrix.
11. Explain cost/benefit analysis value chain analysis, and benchmarking as strategic-
management tools.
. 6-2
A Comprehensive Strategic-Management Model
6-3
Internal Audit, Competitive Advantage, and Distinctive
Competencies
• Building competitive advantage involves capitalizing on
distinctive competencies
• Distinctive competencies are a firm’s strengths that
cannot be easily matched or imitated by competitors
• Knowing organizational strengths and weaknesses is
required to formulate strategies and to build competitive
advantage
• Knowing the strengths and weaknesses comes from
analyzing organizational functions and process. Such
analysis is known as internal analysis, internal
assessment, or the internal audit
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The Resource-Based View (RBV)
• It is an approach to competitive advantage which contends that
internal resources are more important for a firm than external
factors in achieving and sustaining competitive advantage
• Proponents of the RBV contend that organizational performance
will primarily be determined by internal resources that can be
grouped into three all-encompassing categories:
o Physical resources: plant and equipment, location, technology, raw material, machines, etc.
o Human resources: employees, training, experience, intelligence, knowledge, skills, abilities,
etc.
o Organizational resources: structure, planning processes, information systems, patents,
trademarks, copyrights, databases, etc.
• For a resource to be valuable, it must be either (1) rare, (2) hard
to imitate, or (3) not easily substitutable.
• These three characteristics of resources enable a firm to
implement strategies that improve its efficiency and effectiveness
and lead to a sustainable competitive advantage.
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The Process of Performing an Internal Audit
• The internal audit requires gathering and assimilating
information about the firm’s management, marketing,
finance/accounting, production/operations, research and
development (R&D), and management information
systems operations
• The internal audit provides more opportunity for
participants to understand how their jobs, departments,
and divisions fit into the whole organization
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Integrating Strategy and Culture
• Organizational culture can be defined as “ a pattern of behavior
that has been developed by an organization as it learns to cope
with its problem of external adaptation and internal integration,
and that has worked well enough to be considered valid and to
be taught to new members as the correct way to perceive think,
and feel.”
• Organizational culture significantly affects business decisions
and thus must be evaluated during an internal strategic-
management audit.
• If strategies can capitalize on cultural strengths, such as a strong
work ethic or highly ethical beliefs, then management often can
swiftly and easily implement changes.
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Example Cultural Products Defined
6-8
Management
• The functions of management consist of five
basic activities: planning, organizing,
motivating, staffing, and controlling.
• These activities are important to assess in
strategic planning because an organization
should continually capitalize on its
management strengths and improve on its
management weaknesses.
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The Basic Functions of Management
Stages of Strategic-
Function Description Management Process
When Most Important
Consists of managerial activities related to preparing for the future
Planning such as forecasting, establishing objectives, devising strategies, Strategy Formulation
developing policies, and setting goals
Includes managerial activities that result in a structure of task and
authority relationships. Specific areas include organizational design,
Organizing Strategy Formulation
job specification, job description, job specialization, span of control,
unity of command, coordination, job design, and job analysis
Involves efforts directed toward shaping human behavior. Specific
topics include leadership, communication, work groups, behavior
Strategy
Motivating modification, delegation, job enrichment, job satisfaction, needs
Implementation
fulfillment, organizational change, employee morale, and managerial
morale
Involves activities that are centered on personnel and human resource
management. Included are wage and salary administration, employee
benefits, interviewing, hiring, firing, training, management Strategy
Staffing
development, employee safety, career development, personnel Implementation
research, discipline, grievance procedures, union relations, and public
relations
Refers to managerial activities directed toward ensuring that actual
results are consistent with planned results. These include quality
Controlling Strategy Evaluation
control, financial control, sales control, inventory control, analysis of
variances, rewards, and sanctions.
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Management Audit Checklist of Questions
1. Does the firm use strategic-management concepts?
2. Are company objectives and goals measurable
3. and well communicated?
4. Do managers at all hierarchical levels plan effectively?
5. Do managers delegate authority well?
6. Is the organization’s structure appropriate?
7. Are job descriptions and job specifications clear?
8. Is employee morale high?
9. Are employee turnover and absenteeism low?
[Link] organizational reward and control mechanisms
effective?
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Marketing
Marketing: the process of defining, anticipating, creating,
and fulfilling customers’ needs and wants for products and
services
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Functions of Marketing
Function Description/Related issues
• The examination and evaluation of consumer needs, desires, and wants. Involves
administering customer surveys, analyzing consumer information, evaluating market
Customer
positioning strategies, developing customer profiles, and determining optimal market
analysis
segmentation strategies
• Essential in developing an effective mission statement
Selling Selling includes many marketing activities such as advertising, sales promotion, publicity,
products/ personal selling, sales force management, customer relations, and dealer relations. Such
services activities are particularly important to pursue a market penetration strategy
Product • Includes activities such as test marketing; product and brand positioning; devising
warranties; packaging; determining product options, features, style, and quality; deleting
and service
old products; and providing for customer service
planning
• Important when a company is pursuing product development or diversification
• Five major stakeholders affect pricing decisions: consumers, governments, suppliers,
distributors, and competitors
• Sometimes an organization will pursue a forward integration strategy primarily to gain
Pricing/ better control over prices charged to consumers
distribution • Distribution includes warehousing, distribution channels, distribution coverage, retail site
locations, sales territories, inventory levels and location, transportation carriers,
wholesaling, and retailing. Distribution is especially important when a firm is striving to
implement a market development or forward integration strategy
Marketing the systematic gathering, recording, and analyzing of data about problems relating to the
research marketing of goods and services. It can uncover critical strengths and weaknesses
Involves determining the merit of a decision. Involves computing the total costs associated
Cost benefit
with a decision, estimating the total benefits from the decision, and comparing the total costs
analysis
with the total benefits
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Desirable Characteristics of Ads Today
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Marketing Audit Checklist of Questions
1. Are markets segmented effectively?
2. Is the organization positioned well among competitors?
3. Has the firm’s market share been increasing?
4. Are present channels of distribution reliable and cost effective?
5. Does the firm have an effective sales organization?
6. Does the firm conduct market research?
7. Are product quality and customer service good?
8. Are the firm’s products and services priced appropriately?
9. Does the firm have an effective promotion, advertising, and publicity
strategy?
[Link] marketing, planning, and budgeting effective?
11. Do the firm’s marketing managers have adequate experience and training?
[Link] the firm’s Internet presence excellent as compared to rivals?
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Finance/Accounting Functions
The functions of finance/accounting comprise three
decisions:
1. the investment decision
o the allocation and reallocation of capital and resources to projects, products,
assets, and divisions of an organization
2. the financing decision
o determines the best capital structure for the firm and includes examining
various methods by which the firm can raise capital
3. the dividend decision
o concern issues such as the percentage of earnings paid to stockholders, the
stability of dividends paid over time, and the repurchase or issuance of stock
o determine the amount of funds that are retained in a firm compared to the
amount paid out to stockholders
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Financial Ratios
• Financial ratios are computed from the income statement
and balance sheet
• Financial rations are like pictures, reflecting the situation
at one point in time
• Financial ratio analysis must go beyond the actual
calculation and interpretation of ratios. Analysis should
address:
1. How has each ratio changed over time?
2. How does each ratio compare to industry norms?
3. How does each ratio compare with key competitors?
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A Summary of Key Financial Ratios
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A Summary of Key Financial Ratios
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A Summary of Key Financial Ratios
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A Summary of Key Financial Ratios
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Finance/Accounting Audit Checklist
1. Where is the firm financially strong and weak as indicated by financial
ratio analyses?
2. Can the firm raise needed short-term capital?
3. Can the firm raise needed long-term capital through debt and/or equity?
4. Does the firm have sufficient working capital?
5. Are capital budgeting procedures effective?
6. Are dividend payout policies reasonable?
7. Does the firm have good relations with its investors and
stockholders?
8. Are the firm’s financial managers experienced and well trained?
9. Is the firm’s debt situation excellent?
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Production/Operations
• Production/operations function consists of all those
activities that transforms inputs into goods and services
• Production/operations management deals with inputs,
transformations, and outputs that vary across industries
and markets.
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The Basic Functions (Decisions) Within
Production/Operations
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Implications of Various Strategies on
Production/Operations
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Production/Operations Audit Checklist
1. Are supplies of raw materials, parts, and subassemblies
reliable and reasonable?
2. Are facilities, equipment, machinery, and offices in good
3. condition?
4. Are inventory-control policies and procedures effective?
5. Are quality-control policies and procedures effective?
6. Are facilities, resources, and markets strategically
located?
7. Does the firm have technological competencies?
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Research and Development (R&D)
• Some companies do not need R&D
• Some companies rely heavily on R&D to compete and
spend significant amount of money on R&D function
• R&D contributes to innovation in products and/or
innovation in production/transformation processes
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Research and Development Audit
1. Does the firm have R&D facilities? Are they adequate?
2. If outside R&D firms are used, are they cost-effective?
3. Are the organization’s R&D personnel well qualified?
4. Are R&D resources allocated effectively?
5. Are management information and computer systems
adequate?
6. Is communication between R&D and other
organizational units effective?
7. Are present products technologically competitive?
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Management Information Systems
• A management information system’s purpose is
to improve the performance of an enterprise by
improving the quality of managerial decisions
• An effective information system thus collects,
codes, stores, synthesizes, and presents
information in such a manner that it answers
important operating and strategic questions
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Management Information Systems Audit
1. Do all managers in the firm use the information system to make decisions?
2. Is there a chief information officer or director of information systems position
in the firm?
3. Are data in the information system updated regularly?
4. Do managers from all functional areas of the firm contribute input to the
information system?
5. Are there effective passwords for entry into the firm’s information system?
6. Are strategists of the firm familiar with the information systems of rival firms?
7. Is the information system user-friendly?
8. Do all users of the information system understand the competitive
advantages that information can provide firms?
9. Are computer training workshops provided for users of the information
system?
[Link] the firm’s information system continually being improved in content- and
user-friendliness?
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Value Chain Analysis (VCA)
• Value chain analysis (VCA)
o refers to the process whereby a firm determines the costs
associated with organizational activities from purchasing raw
materials to manufacturing product(s) to marketing those
products
o aims to identify where low-cost advantages or disadvantages
exist anywhere along the value chain from raw material to
customer service activities
• Benchmarking
o an analytical tool used to determine whether a firm’s value
chain activities are competitive compared to rivals and thus
conducive to winning in the marketplace
o entails measuring costs of value chain activities across an
industry to determine “best practices”
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Transforming Value Chain Activities into
Sustained Competitive Advantage
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The Internal Factor Evaluation (IFE) Matrix
[Link] key internal factors (strengths
and weaknesses) as identified in the
internal audit (list 20 factors)
1 2 3 4
[Link] a weight that ranges from
0.0 (not important) to 1.0 (all-
important) to each factor to indicate
relative importance of the factor to
success in the firm’s industry. The
sum of all weight must equal 1.0.
[Link] a 1-4 rating to each factor to
indicate whether that factor
represents a major weakness (1), a
minor weakness (2), a minor
strength (3) or a major strength (4)
[Link] each factor’s weight by its
rating to determine a weighted
score for each variable.
[Link] the weighted scores for each
variable to determine the total
weighted score for the organization
(range from 1-4 with average of 2.5)
Score that is well below 2.5 indicates
the firm is weak internally, while a
score significantly above 2.5 indicates
the firm is strong internally. 5
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