THE INTERNAL

ASSESSMENT
Chapter IV

THE NATURE OF AN
INTERNAL AUDIT

A COMPREHENSIVE STRATEGIC MANAGEMENT MODEL

KEY INTERNAL FORCES

Distinctive Competencies
A firms strengths that cannot be easily
matched or imitated by competitors.

Building competitive advantages

involves taking advantage of distinctive
competencies.

THE PROCESS OF PERFORMING AN

INTERNAL AUDIT
The Internal Audit
Requires gathering and assimilating
information about the firms management,
marketing, finance/accounting,
production/operations, research and
development (R&D), and management
information systems operations.
Provides more opportunity for participants to
understand how their jobs, departments, and
divisions fit into the whole organization.

WILLIAM KING
The development of conclusions on the 10 to
20 most important strengths and weaknesses
can be, as any experienced manager knows, a
diffi cult task, when it involves managers
representing various organizational interests
Developing
20-page list of strengths and
and points ofaview.
weaknesses could be accomplished relatively
easily, but a list of the 10 to 15 most
important ones involves signifi cant analysis
This is true because of
and negotiation.
the judgments that are required and the
impact which such a list will inevitably have as
it is used in the formulation, implementation,
and evaluation of strategies.

ANSOFF
During the fi rst fi fty years, successful
fi rms
focused
their
energies
on
optimizing the performance of one of the
principal
functions:
production/operations,
or
Today, due to growingR&D,
complexity
marketing.
and
dynamism of the environment,
success increasingly depends on a
This transition
from a single
function
judicious
combination
of
several
focus to infl
a uences.
multifunctional focus is
functional
essential
for
successful
strategic
management

GEORGE
We may conceptually separate planning
for the purpose of theoretical discussion
and analysis, but in practice, neither is it
a distinct entity nor is it capable of being
separated.
The planning function is mixed with
andother business functions
all
like ink once mixed
with water, it cannot be set apart. It is
spread throughout and is a part of the
whole managing an organization

THE RESOURCEBASED VIEW

THE RESOURCE-BASED VIEW (RBV)

The Resource Based View
(RBV) Approach
Contends that internal resources are
more important for a firm than external
factors in achieving and sustaining
competitive advantage

ROBERT GRANT
volatile
In a world where customer preferences
are
changing
volatile, the identity of customers
is changing
and the technologies for serving customer
requirementsevolving
are
continually
evolving,
an
externally focused orientation does not provide a
secure foundation for formulating long term
strategy. When the external environment is in
the state of fl ux, the fi rms own resources and
Hence,
a stable
defi nition
of on
a
capabilities may be a much
more
basis
business
terms
of identity.
what it is
capable
of doing
which to in
defi
ne its
Hence,
a defi
nition
may
er a more
durable
than
of
a off
business
in terms
ofbasis
whatfor
it strategy
is capable
of
a defi nition
based
need which
doing
may off
er aupon
morethedurable
basis the
for
business than
seeksatodefi
satisfy
strategy
nition based upon the need
which the business seeks to satisfy

THE RESOURCE-BASED VIEW (RBV)

Proponents of the RBV contend that
organizational performance will
primarily be determined by internal
resources that can be grouped into
these three all-encompassing
categories:
Physical Resources
Human Resources
Organizational Resources

Physical
Resources
Plant and
Equipment
Location
Technology
Raw Materials
Machines

Human
Resources

Employees
Experience
Knowledge
Training
Intelligence
Skills
Abilities

Organizational
Resources
Firm structure
Planning and
Process
Information
Systems
Patent
Trademarks
Copyright
Database

THE RESOURCE-BASED VIEW (RBV)

For a resource to be valuable, it must
be either:
1. Rare
2. hard to imitate
3. not easily substitutable

These three characteristics of

resources enable a fi rm to implement
strategies that improve its effi ciency
and eff ectiveness and lead to a
sustainable competitive advantage

INTEGRATING
STRATEGY AND
CULTURE

INTEGRATING STRATEGY AND

CULTURE
Organizational culture signifi cantly
aff ects 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.

EXAMPLES OF CULTURAL PRODUCTS

INTEGRATING STRATEGY AND

CULTURE
Lorsch found that executives in successful
companies are emotionally committed to
the fi rms culture, but he concluded that
culture can inhibit strategic management
in two basic ways:
First, managers frequently miss the significance
of changing external conditions because they are
blinded by strongly held beliefs.
Second, when a particular culture has been
effective in the past, the natural response is to
stick with it in the future, even during times of
major strategic change.

POSSIBLE ASPECTS OF AN
ORGANIZATIONS CULTURE

MANAGEMENT

THE FUNCTIONS OF MANAGEMENT

THE FUNCTIONS OF MANAGEMENT

The functions of management consist of fi ve
basic activities:

Planning
Organizing
Motivating
Staffi ng
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.

PLANNING
Planning
the process by which one determines whether to attempt a
task, works out the most eff ective way of reaching desired
objectives and prepares to overcome unexpected diffi culties
with adequate resources.

The benefi ts of planning:

Helps in achieving maximum eff ect from a given eff ort
Enables to take into account relevant factors and focus on
the critical ones
Gather needed resources to carry out tasks eff ectively and
effi ciently
Identify and take advantage of external opportunities and
minimize the impact of external threats
Develop synergy
Allow to adapt to changing markets

ORGANIZING
Organizing
Assembling and coordinating the human, fi nancial,
physical, informational, and other resources needed to
achieve goals.
Determining who does what and who reports to whom.

Three sequential activities

1. Work Specialization
Breaking down tasks into jobs and the development of job
descriptions and job specifi cations.

2. Departmentalization
Combining jobs to form departments to make an
organizational structure, span of control and chain of
command.

3. Delegating Authority
Giving authority and responsibility to employees.

MOTIVATING
Motivating
The process of influencing people to
accomplish specific objectives

Four Major Components

Leadership
Developing a vision of the firms future and inspiring
people to work hard to achieve that vision.

Group Dynamics
Informal groups that aff ect the employees morale
and satisfaction

Communication
Organizational Change

STAFFING
Staffi ng
Controls all recruitment and personnel needs
of the firm
Also called personnel management of human
resource management.
Includes activities with employees like:
Recruiting
Interviewing
Testing
Selecting
Orienting

Training
Developing
Caring for
Evaluating
Rewarding
Disciplining

Promoting
Transferring
Demoting
Dismissing
Managing
union
relations

CONTROLLING
Controlling
Includes activities undertaken to ensure that
actual operations conform to planned
operations.

Four Basic Steps

Establishing performance standards
Measuring individual and organizational
performance
Comparing actual performance to planned
performance standards
Taking corrective actions

MANAGEMENT AUDIT CHECKLIST OF

QUESTIONS
1. Does the fi rm use strategic-management
concepts?
2. Are company objectives and goals measurable
and well communicated?
3. Do managers at all hierarchical levels plan
eff ectively?
4. Do managers delegate authority well?
5. Is the organizations structure appropriate?
6. Are job descriptions and job specifi cations
clear?
7. Is employee morale high?
8. Are employee turnover and absenteeism low?
9. Are organizational reward and control

MARKETING

MARKETING AND ITS FUNCTIONS

Marketing
the process of defining, anticipating, creating, and
fulfilling customers needs and wants for products and
services.

Functions of Marketing
Customer Analysis
Selling Products/Services
Product and Service Planning
Pricing
Distribution
Marketing Research
Cost/Benefi t Analysis

CUSTOMER ANALYSIS
Customer analysis
the examination and evaluation of consumer
needs, desires, and wants
essential in developing an effective mission
statement
involves the following activities
administering customer surveys
analyzing consumer information
evaluating market positioning strategies
developing customer profiles
determining optimal market segmentation
strategies

SELLING PRODUCTS/SERVICES
Selling
generally determines the success of strategy
implementation.

Involves many marketing activities

such as:
Advertising
Sales Promotion
Publicity
Personal Selling
Sales Force Management
Customer Relations
Dealer Relations

SELLING PRODUCTS/SERVICES

PRODUCT AND SERVICE PLANNING

Product and service planning
Vital when a company is pursuing product
development or diversification
includes activities such as:
Test marketing
Product and brand positioning
Devising warranties
Packaging
Determining product options
Features
Style and quality
Deleting old products
Providing for customer service

PRICING
Pricing
Sometimes an organization will pursue a forward
integration strategy primarily to gain better
control over prices charged to consumers

Stakeholders that aff ect pricing

decisions:
Consumer
Governments
Suppliers
Distributors
Competitors

DISTRIBUTION
Distribution
especially important when a firm is striving to
implement a market development or forward
Integration strategy

Includes the following activities:

Warehousing
Distribution channels
Distribution coverage
Retail site locations
Sales territories
Inventory levels and location
Transportation carriers
Wholesaling
Retailing

MARKETING RESEARCH
Marketing research
the systematic gathering, recording,
and analyzing of data about problems
relating to the marketing of goods and
services
can uncover critical strengths and
weaknesses

COST/BENEFIT ANALYSIS
Three steps are required to perform a
cost/benefi t analysis:
1. compute the total costs associated
with a decision,
2. estimate the total benefi ts from the
decision,
3. compare the total costs with the total
benefi ts.

MARKETING AUDIT CHECKLIST OF

QUESTIONS
Are markets segmented eff ectively?
Is the organization positioned well among
competitors?
Has the fi rms market share been increasing?
Are present channels of distribution reliable
and cost eff ective?
Does the fi rm have an eff ective sales
organization?
Does the fi rm conduct market research?
Are product quality and customer service
good?
Are the fi rms products and services priced

MARKETING AUDIT CHECKLIST OF

QUESTIONS
Does the fi rm have an eff ective promotion,
advertising, and publicity strategy?
Are marketing, planning, and budgeting
eff ective?
Do the fi rms marketing managers have
adequate experience and training?
Is the fi rms Internet presence excellent as
compared to rivals?

FINANCE/ACCOUNTING
FUNCTIONS

FINANCE/ACCOUNTING FUNCTIONS

Three decisions comprising

finance/accounting functions:
The investment decision
The financing decision
The dividend decision

INVESTMENT DECISION
Investment decision
the allocation and reallocation of
capital and resources to projects,
products, assets, and divisions of an
organization
also known as capital budgeting
required to successfully implement
strategies

FINANCING DECISION
Financing decision
determines the best capital structure for the fi rm and
includes examining various methods by which the fi rm
can raise capital
Must consider both short-term and long-term needs
for working capital.

Key fi nancial ratios that indicate

whether a fi rms fi nancing decision are
eff ective:
Debt-to-equity ratio
Debt-to-total-assets ratio

DIVIDEND DECISIONS
Dividend decisions
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
determine the amount of funds that are retained in a
firm compared to the amount paid out to stockholders

Financial ratios that help evaluate

dividend decisions:
Earnings-per-share ratio
Dividends-per-share ratio
Price-earnings ratio

DIVIDEND DECISION
Reasons for paying dividends even
when funds could be better
reinvested:
1.Paying cash is customary
2.Dividends represent a sales point for
investment bankers.
3.Shareholders often demand for
dividends.
4.A myth exists that paying dividends
will result in higher stock prices.

FINANCIAL RATIO ANALYSIS

Financial Ratio Analysis
The most widely used method for determining
an organizations strengths and weaknesses
in the investment, financing, and dividend
areas
Can signal strengths or weaknesses in
management, marketing, production, research
and development, and management
information systems activities.

Trend Analysis
A useful technique that incorporates both
time and industry average dimensions of
financial ratios.

FINANCIAL RATIO TREND ANALYSIS

BASIC TYPES OF FINANCIAL RATIOS

Liquidity Ratios
Measure a fi rms ability to meet maturing short-term
obligations

Leverage Ratios
Measure the extent to which a fi rm has been fi nanced by
debt

Activity Ratios
Measure how eff ectively a fi rm is using its resources

Profi tability Ratios

Measure managements overall eff ectiveness as shown by
the returns generated on sales and investment

Growth Ratios
Measure the fi rms ability to maintain its economic position
in the growth of the economy and industry

A SUMMARY OF KEY
FINANCIAL RATIOS

A SUMMARY OF KEY
FINANCIAL RATIOS

A SUMMARY OF KEY
FINANCIAL RATIOS

A SUMMARY OF KEY
FINANCIAL RATIOS

OTHER FACTORS THAT AFFECT A

FIRMS FINANCIAL CONDITION
Management, marketing management,
production/operations, research and
development, and management information
systems decisions.
Actions by competitors, supplies, distributors,
creditors, customers and shareholders.
Economic, social, cultural, demographic,
environmental, political, governmental, legal,
and technological trends.

BEFORE AND AFTER BREAKEVEN

CHART WHEN PRICES ARE LOWERED

BEFORE AND AFTER BREAKEVEN CHART

WHEN FIXED COSTS ARE INCREASED

BEFORE AND AFTER BREAKEVEN CHART

WHEN PRICES ARE LOWERED AND FIXED
COSTS ARE INCREASED

FINANCIAL RATIO ANALYSIS

How has each ratio changed over
time?
How does each ratio compare to
industry norms?
How does each ratio compare with
key competitors?

LIMITATIONS OF FINANCIAL RATIOS

Based on Accounting Data
Firms differ in treatment of some items (e.g.
depreciation, inventory valuation).

Seasonal Factors
Can influence comparative ratios.

Conformity or departure with

industry averages
Does not establish with certainty that a firm
is performing normally, or that it is well
managed.

FINANCE/ACCOUNTING AUDIT
CHECKLIST
1. Where is the fi rm fi nancially strong and
weak as indicated by fi nancial ratio
analyses?
2. Can the fi rm raise needed short-term
capital?
3. Can the fi rm raise needed long-term
capital through debt and/or equity?
4. Does the fi rm have suffi cient working
capital?
5. Are capital budgeting procedures
eff ective?

FINANCE/ACCOUNTING AUDIT
CHECKLIST
6. Are dividend payout policies
reasonable?
7. Does the firm have good relations
with its investors and stockholders?
8. Are the fi rms financial managers
experienced and well trained?
9. Is the fi rms debt situation
excellent?

PRODUCTION AND
OPERATIONS

PRODUCTION/OPERATIONS
Production/operations function
consists of all those activities that transforms inputs
into goods and services
deals with inputs, transformations, and outputs that
vary across industries and markets.

Five Functions/Decision Areas

Process
Capacity
Inventory
Workforce
Quality

THE BASIC FUNCTIONS (DECISIONS)

WITHIN PRODUCTION/OPERATIONS

IMPLICATIONS OF VARIOUS STRATEGIES

ON PRODUCTION/OPERATIONS

PRODUCTION/OPERATIONS
AUDIT CHECKLIST
1. Are supplies of raw materials, parts, and
subassemblies reliable and reasonable?
2. Are facilities, equipment, machinery, and
offi ces in good condition?
3. Are inventory-control policies and
procedures eff ective?
4. Are quality-control policies and procedures
eff ective?
5. Are facilities, resources, and markets
strategically located?
6. Does the fi rm have technological
competencies?

RESEARCH AND
DEVELOPMENT

RESEARCH AND DEVELOPMENT

FUNCTION
The fifth major area of internal
operations that should be
examined for specific strength and
weaknesses is research and
development (R&D)

RESEARCH AND DEVELOPMENT

FUNCTION
Organization invest in R&D
because:
They believe it will lead to a superior
product and service
It will give them competitive advantage

Improving manufacturing process to

reduce cost
Improving product quality

RESEARCH AND DEVELOPMENT

FUNCTION
The overall mission of Research and
Development
supporting existing businesses
launching new businesses
developing new products
improving product quality
improving manufacturing effi ciency
broadening technological capabilities

FORMS OF R&D
Internal Research and Development
An organization operates its own R&D
department

Contract Research and

Development
A firm hires independent researchers or
independent agencies to develop specific
products

R&D SPENDING AT TEN SAMPLE

COMPANIES

RESEARCH AND DEVELOPMENT

AUDIT
1. Does the fi rm have R&D facilities? Are they
adequate?
2. If outside R&D fi rms are used, are they costeff ective?
3. Are the organizations R&D personnel well
qualifi ed?
4. Are R&D resources allocated eff ectively?
5. Are management information and computer
systems adequate?
6. Is communication between R&D and other
organizational units eff ective?
7. Are present products technologically
competitive?

MANAGEMENT
INFORMATION SYSTEMS

MANAGEMENT INFORMATION
SYSTEMS
Purpose
to improve the performance of an enterprise
by improving the quality of managerial
decisions

An eff ective information system thus

collects, codes, stores, synthesizes, and
presents information in such a manner
that it answers important operating and
strategic questions.

MANAGEMENT INFORMATION
SYSTEMS
Data are input to the system and
transformed into an output.
Data become information only when
they are evaluated, fi ltered, condensed,
analyzed, and organized for a specifi c
purpose, problem, individual, or time.

MANAGEMENT INFORMATION
SYSTEMS AUDIT
1. Do all managers in the fi rm use the
information system to make decisions?
2. Is there a chief information offi cer or
director of information systems position in
the fi rm?
3. Are data in the information system updated
regularly?
4. Do managers from all functional areas of the
fi rm contribute input to the information
system?
5. Are there eff ective passwords for entry into
the fi rms information system?

MANAGEMENT INFORMATION
SYSTEMS AUDIT
6. Are strategists of the fi rm familiar with the
information systems of rival fi rms?
7. Is the information system user-friendly?
8. Do all users of the information system
understand the competitive advantages that
information can provide fi rms?
9. Are computer training workshops provided
for users of the information system?
10.Is the fi rms information system continually
being improved in content- and userfriendliness?

VALUE CHAIN ANALYSIS

VALUE CHAIN ANALYSIS (VCA)

Value chain analysis (VCA)
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
aims to identify where low-cost advantages or
disadvantages exist anywhere along the value
chain from raw material to customer service
activities
can enable a firm to further identify its own
strengths and weaknesses , especially as
compared to competitors value chain analyses
and their own data examined over time

VALUE CHAIN ANALYSIS

Core Competence
A value chain activity that a firm performs
especially well

Distinctive Competence
When a core competence evolves into a major
competitive advantage

TRANSFORMING VALUE CHAIN

ACTIVITIES INTO SUSTAINED
COMPETITIVE ADVANTAGE

BENCHMARKING
Benchmarking
an analytical tool used to determine whether
a firms value chain activities are competitive
compared to rivals and thus conducive to
winning in the marketplace
entails measuring costs of value chain
activities across an industry to determine
best practices among competing firms for
the purpose of duplicating or improving upon
those best practices.

THE INTERNAL FACTOR

EVALUATION (IFE)
MATRIX

THE INTERNAL FACTOR EVALUATION

(IFE) MATRIX
Internal Factor Evaluation (IFE)
Matrix
A strategy formulation tool that
summarizes and evaluates the major
strengths and weaknesses in the
functional areas of a business and
provides a basis for identifying and
evaluating relationships among those
areas.

FIVE STEPS IN DEVELOPING AN IFE

MATRIX
Step 1: List key internal factors as
identifi ed in the Internal-Audit
Process.
Use a total of 10 to 20 internal factors,
including both strengths and weaknesses.
List the strengths first, then the weaknesses.
Be as specific as possible, using percentages,
ratios, and comparative numbers.

FIVE STEPS IN DEVELOPING AN IFE

MATRIX
Step 2: Assign a weight that ranges
from 0.0 (not important) to 1.0 (allimportant)
The weight assigned to a given factor indicates
the relative importance of the factor to being
successful in the firms industry.
Regardless of whether a key factor is an internal
strength or weakness, factors considered to have
the greatest effect on organizational performance
should be assigned the highest weights.
The sum of all weights must equal 1.0

FIVE STEPS IN DEVELOPING AN IFE

MATRIX
Step 3: Assign a 1-to-4 rating to each
factor to indicate whether that factor
represents a weakness or a strength
Strengths must receive a 3 or 4
Weaknesses must receive a 1 or 2
Ratings are company based, whereas
weaknesses
1
2
3
4

=
=
=
=

Major
Minor
Minor
Major

weakness
weakness
strength
strength

FIVE STEPS IN DEVELOPING AN IFE

MATRIX
Step 4: Multiply each factors rate by
its rating to determine a weighted score
for each variable
Step 5: Sum the weighted scores for
each variable to determine the total
weighted score for the organization.

A SAMPLE INTERNAL FACTOR

EVALUATION MATRIX FOR A RETAIL
COMPUTER STORE