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Nature of Internal Audit

In strategic management, an internal audit determines the organization’s position within its industry. This process gathers information about key
internal factors to ascertain the strengths and weaknesses of the organization in different areas.

 Internal audit requires gathering and assimilating information about the firm’s management, marketing, finance, production, operations,
research and development and MIS operations.

 Performing an internal audit provides more opportunity for participants to understand how jobs, departments, clusters, and divisions fit
into the whole organization. Which greatly benefits managers and employees in performing better when they have a thorough
understanding on how their work affects other areas of the firm.
 There are certain strengths and weaknesses in different functional areas of almost every organization. That is why there’s no single
organization that can be completely equal in its all functional areas. Indeed, the internal strategic management audit is essential for the
success of the organization.
 The process of internal auditing starts with identifying the strengths and weaknesses of the organization by the managers and employees.
Certain information from different functional areas are collected and arranged so that members of the organization better understand the
tasks of different departments and divisions of the firm. This understanding helps managers and employees to perform their duties and
responsibilities more effectively because their works will influence other functional areas of the organization.
 An organization that does not perform Internal Strategic Management Audit lacks interaction and understanding of its finances and issues
arising within the organization. 

Resource-based View (RBV)

RBV is an approach to achieving competitive advantage that emerged between 1980s and 1990s after the major works published by Wernerfelt,
B., Prahalad and Hamel and Barney, J. The supporters of this approach argue that organizations should look inside the company to find the
sources of competitive advantage instead of looking at its competitive environment.

 According to RBV, it is much more feasible to exploit external opportunities using existing resources in a new way rather than trying to
acquire new skills for each different opportunity. The basic premise of RBV is that the nature of a firm’s internal resources should be
considered first and foremost in devising strategies which leads to sustainable competitive advantage. 
 The approach asserts that it is advantageous for a firm to pursue a strategy that is not currently being implemented by any competing
firm. For a resource to be valuable, it must be either rare, hard to imitate and organized to capture its value. These characteristics
enable the firm to implement strategies that improve its efficiency and effectiveness to lead to a more sustainable competitive
advantage. Hence, RBV has continued to grow in popularity and continues to seek a better understanding of the relationship between
resources and sustained competitive advantage in strategic management.

Illustration

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Internal Departments

·         Management - According to Kreitner (n.d.), “management is the process of working with and through others to achieve organizational
objectives in a changing environment. Central to this process is the effective and efficient use of limited resources”. According to David (2011),
management has different functions such as planning which is part of strategy formulation; organizing, motivating, staffing as part of strategy
implementation; and controlling as part of strategy evaluation

 Planning - According to David (2011), “Planning consists of all those managerial activities related to preparing for the future. Specific tasks
include forecasting, establishing objectives, devising strategies, developing policies, and setting goals”. 
o By means of this, organizations can calculate and see the risk of making a decision ahead of time before the actual
implementation.
o If carefully studied, it can utilize resources and avoid undesirable expenses on the part of the organization.
o In doing a planning, managers should be open in receiving data and information around their environment as there can be some
things that are essential to what he/she is planning. Hence, managers should be open to communicate and collaborate with the
employees, as these people are doing jobs differently and have been exposed to different areas of the business. In which at times,
managers tend to be overlooked. 

 Organizing - According to David (2011), “Organizing includes all those managerial activities that result in a structure of task and authority
relationships. Specific areas include organizational design, job specialization, job descriptions, job specifications, span of control, unity of
command, coordination, job design, and job analysis”.
o The main reason as to why management needs to organize the organization is for everyone or all the employees to know as to
what their specific involvement is in attaining the organizational goal. It answers the questions, who will be the person in
command? Who decided over this situation? With this function, it creates the organization to have a chain of command, guided
with each individual job description.
o The people who are doing a combining job are called departments.
o Organizations should always make clear to each employee what are only their tasks. In addition, managers as well should watch
themselves as to whether they go beyond their boundary of giving tasks to the unassigned employee. 

 Motivating - According to David (2011), “Motivating involves efforts directed toward shaping human behavior. Specific topics include
leadership, communication, work groups, behavior modification, delegation of authority, job enrichment, job satisfaction, needs fulfillment,
organizational change, employee morale, and managerial morale”.
o Some managers overlooked the importance of motivating their teammates within their departments. They tend to work daily
without considering whether the other employees still have the will to work harder.
o Some tend to disregard this one thing that can push an employee to go further. Motivation can also explain why if there are two
employees doing the same job why one of them is giving such hard effort and the other is not.

 Staffing - According to David (2011), “Staffing activities are centered on personnel or human resource management.. Included are wage and
salary administration, employee benefits, interviewing, hiring, firing, training, management development, employee safety, affirmative
action, equal employment opportunity, union relations, career development, personnel research, discipline policies, grievance procedures,
and public relations.

 Controlling - According to David (2011), “Controlling refers to all those managerial activities directed toward ensuring that actual results are
consistent with planned results. Key areas of concern include quality control, financial control, sales control, inventory control, expense
control, analysis of variances, rewards, and sanctions”.
o This function includes for the manager to check as to whether currently applying strategies are conforming to their intended
outcome. On the note that it does not, managers should make amendments within their scope of management.

·         Marketing is the process of defining or fulfilling a customer's needs and wants. It is guided by its seven basic functions; (1) customer
analysis, (2) selling products/services, (3) product and service planning, (4) pricing, (5) distribution, (6) marketing research, and (7) opportunity
analysis.

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 Customer Analysis - this is the process of knowing your customer, by identifying who they really are; what are their wants, needs, and
desires; what are they doing in life; what are their ages; what are their buying patterns and behavior etc.
o Most likely analysis of customer are done grounded on researches about the customers like customer surveys, data bank of the
business, public documents, marketing research etc.

 Selling products/services - this activity is about how the organization should make their customer buy the product and services. According to
David, F., selling “includes many marketing activities, such as advertising, sales promotion, publicity, personal selling, sales force
management, customer relations, and dealer relations”.

 Product and Service planning - According to David F., “product and service planning includes activities such as test marketing; product and
brand positioning; devising warranties; packaging; determining product options, features, style, and quality; deleting old products; and
providing for customer service”.
o This is important as this describes the present and future of the product/service. It’s a fact that a business will not be able to run
without a product or service.
o Product defines the business product/service current state as what it is in the market and what is their product in the market.
o Furthermore, by studying its details, businesses would be able to understand what they should do in the future

 Pricing - this is the area that is being affected by different stakeholders from time-to-time, in some selected commodities, government gave
an “SRP” or selling retail price, in which, business who sell those products must adhere to that SRP or else, they would be considered as
violators of law.
o Consumers also affect the pricing in a way that there are products in the market nowadays that tend to become higher because
people are consuming it in an increasing manner.
o Suppliers can also affect the pricing of a business’ product and services, like, every time a certain supplier increases their price,
some businesses tend to think that if their supplier’s price changes so does their product price should also change in order to
cover this increase. By means of this, their additional expenses for the supplier are being covered by the customers.
o Marketing tends to investigate these areas carefully as pricing really does have a significant effect over the customer’s decision
making on choosing the product.

 Distribution - According to David, F., “distribution includes warehousing, distribution channels, distribution coverage, retail site locations,
sales territories, inventory levels and location, transportation carriers, wholesaling, and retailing”.
o Businesses always looking into this distribution as to whether things are going smoothly in these areas. This is vital for business
because this affect the flow of their service and results to customer’s satisfaction or dissatisfaction

 Market Research - According to David F., “Marketing research is the systematic gathering, recording, and analyzing of data about problems
relating to the marketing of goods and services. By means of doing this, businesses can identify their strengths and weaknesses.
o Marketers use different kinds of presentation of the gathered data that can be used in formulating business strategies.

 Opportunity Analysis - According to David F., “involves assessing the costs, benefits, and risks associated with marketing decisions”.
o This can be done by first computing the cost of how much a strategy would cost an organization, next step is assessing the benefit
they could get with it. Then, lastly, comparison of the two to see the opportunity analysis.
o Most likely if the firm gets more of cost rather than benefit it tends organizations may find this strategy unattractive. On the other
hand, if the benefit is greater than the costs, organizations tend to follow that strategy.

·         Finance/Accounting - According to James Van Home, “factors concerning finance and accounting comprises three decisions namely
investment decisions, financing decisions and dividend decisions”. In order to come up with such decisions, an organization must use a method
called financial ratio analysis.

 Ratio analysis can be used both by profit and non-profit organizations. Because this can determine the business’ strengths and
weaknesses. This concerns about where to allocate or reallocation the resources whether tangible asset or cash budget

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 Financing decisions focuses with the capital structure the methods of how business can raise the capital. This kind of decisions must be
both determined in short-term and long-term needs as for the capital needed for the organization to work, issuance of stocks,
increasing of debts and even selling the organization’s assets.
 According to David (2011), “dividend decisions determine the amounts of funds that are retained in a firm compared to the amount
paid out to the firm’s shareholders”. This decision is concerned with issues such as issuance of stocks, stability of dividends, and
percentage earnings.

·         Production/Operations - According to David, “this consists of all those activities that transform inputs into goods and services”. This area of
business deals with inputs, processes and outputs that vary across industries.

 Production planning allows managers to decide on details of the plan as to how production will be done, where site locations should be and
what resources will be needed.
 Production control concerns with the control of schedules, quality and costs of products or services that are being made or delivered.
Continuous improvement allows the managers to analyze data and develop more efficient ways of producing goods or delivering services.

·         Research and Development - includes activities that companies undertake to innovate and introduce new products and services. It allows
the organization to stay ahead of its competition.

 Without and R&D program, a company may not survive on its own and may have to rely on other ways to innovate. With the help of R&D,
organizations can design new products and improve their existing offerings.
 The overall mission of R&D includes supporting existing businesses, helping launch new businesses, developing new products, improving
product quality and manufacturing efficiency as well as broadening the technological capacity of the organization.
 R&D in organizations can take two basic forms such as Internal R&D and External R&D. But many companies use both approaches to
develop new products and formulating and implementing strategies.
 Internal R&D in which an organization operates its own R&D department. On the other hand, external R&D in which an organization hires
independent researchers to develop specific products.

·         Management Information System - MIS’s purpose is to improve the performance of an enterprise by improving the quality of managerial
decisions. MIS collects, stores, and presents information that answers important operating and strategic questions.

 MIS receives raw materials from the external and internal evaluation of an organization then gathers data about marketing, finance,
production, demographics, socio-cultural and etc. These data are integrated in ways needed to support managerial decisions.
 MIS allows data to be evaluated, filtered, condensed, analyzed and organized for a specific purpose, problem, individual and time.

Value Chain Analysis

According to David (2011), this is a process where a firm refers to the process whereby a firm determines the costs associated with
organizational activities (e.g. from purchasing raw materials to manufacturing product(s) to marketing those products). VCA aims to identify
where low-cost advantages or disadvantages exist anywhere along the value chain from raw material to customer service activities.

 Its goal is to recognize which activities are the most valuable to the organization and which could be improved to provide competitive
advantage.
 This analysis reveals where the firm's competitive advantage or disadvantage are.
 To know if a firm’s VCA is competitive enough, a tool called  Benchmarking is used. According to David (2011), “Benchmarking 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”.
 According to David (2011), there are several steps in doing a VA, 

step (1) divide the organization’s operations into specific activities or business process, 

step (2) an analyst attached a cost to each discrete activity. Take note that, costs should be in terms of both time and money. After these, 

step (3) convert the cost data into information by checking for competitive strengths and weaknesses that might relate to competitive advantage
and disadvantage

(example)

Value Chain for a Manufacturing Firm:

OPERATIONS MONTHLY CONSUMPTION COST PER CONSUMPTION

Supplier Costs    

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Raw Materials 4   Php 50,000.00

Fuel 6 Php 5,000.00

Energy 30 Php 3,000.00

Truck Driver 4 Php 3,000.00

Warehouse 30 Php 1,000.00

Production Costs    

Inventory System 30 Php 1,000.00

Computer 30 Php 1,000.00

Maintenance 1 Php 3,000.00

Plant Location 30 Php 1,500.00

Distribution Costs    

Loading 4 Php 500.00

Shipping 8 Php 5,000.00

Trucking 22 Php 2,000.00

Explanations:

1. The time consumption varies depending on how relatable and measurable each activity is in terms of time. As much as possible
choose only time consumption based on the related able time for all activities. They should have an equal measurement of time to
see it’s significance to each other. The reason why on our example it was measured based on monthly basis simply because all the
mentioned activities are relatable and measurable only on monthly basis.

2. There are activities that organization consume every day like plant location, inventory system, computer etc. yet still daily basis
cannot be use as a basis in measuring consumption. Because most of the activities are not a type of activity that they are doing
daily. Hence, it is not advisable and impossible to measure it on a daily basis.

3. Weekly basis type of measurement consumption is also not applicable because there is a specific activity that only happens once
a month like the maintenance under production cost. Weekly basis cannot be used a way to measure a once-a-month activity of an
organization.

4. For clarification, cost per consumption only is the reflection of how much money the organization spend every time they are doing
a certain activity. In line with our example, the actual cost for using and maintain a warehouse in supplier costs is roughly total of
Php 30,000 per month and the number of days they are using this on a monthly basis or thirty (30) days equivalent. Meaning, every
day they are spending Php 1,000 to operate in this warehouse.

Php 30,000 (total cost monthly)

30 Days (no. of days)

Internal Factor Evaluation Matrix

This tool summarizes and evaluates major strengths and weaknesses in the functional areas of business and used as a basis for evaluating
relationships among those areas. Introduced by Fred R. David, this tool is used to summarize information gained from an organization’s analyses
and then it will be evaluated and used to build SWOT analysis.

·         Step 1 Identify 10-20 key internal factors and each key factor should be assigned a weight ranging from 0.0 (low importance) to 1.0 (high
importance).

 The sum of all weights must equal to 1.0.

 The number indicates how important the factor is if a company wants to succeed in an industry.
 If there were no weights assigned, all the factors would be equally important.

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·         Step 2 rate how strong or weak each factor is in a firm.

 The numbers range from 4 to 1, where 4 means a major strength, 3 for minor strength, 2 for minor weakness and 1 for major weakness.

·         Step 3 - Get the weighted scores and total weighted score. This result from weight multiplied by rating.

 Each key factor must receive a score.

 Total Weighted Score is simply the sum of all individual weighted scores.
 The total score of 2.5 is an average score. A low total score indicates that the company is weak against its competitors.

(example)

IFE Matrix done for Retail Computer Store:

Internal Factor Evaluation Matrix

Key Internal Factors Weight Rating Weighted Score

Strengths

1. Average customer purchase increase from $97 to $128 0.07 4 0.28

2. Employee morale is excellent 0.10 3 0.30

3. In-store promotions resulted in 20% increase in sales 0.05 3 0.15

4. Revenues from repair/service segment of store up 16% 0.15 3 0.45

5. Revenue per employee up 19% 0.02 3 0.06

6. Inventory turnover increased from 5.8 to 6.7 0.05 3 0.15

7. Newspaper advertising expenditure increased 10% 0.02 3 0.06

8. Store’s debt-to-total assets ratio declined to 34 percent 0.03 3 0.09

9. In-store technical support personnel have MIS college degrees 0.05 4 0.20

Weaknesses

1. Often customers have to wait and check out 0.1 1 0.05

2. Store has no website 0.07 2 0.10

3. Bathroom in store need refurbishing 0.02 1 0.02

4. Supplier on-time delivery increased to 2.4 days 0.2 1 0.03

5. Carpet and paint in store somewhat in disrepair 0.01 1 0.02

6.  Revenues from software segment of store down 12% 0.10 2 0.20

7.  Location of store negatively impacted by new Highway 34 0.15 2 0.30

8.  Revenues from businesses down 8% 0.04 1 0.04

Total 1.0   2.5

  Interpretation and clarification:

“In IFE Matrix is provided in Table 4-10 for a retail computer store. Note that the two most important factors to be successful in the
retail computer store business are “revenues from repair/service in the store” and “location of the store.” Also note that the store is
doing best on “average customer purchase amount” and “in-store technical support.” The store is having major problems with its
carpet, bathroom, paint, and checkout procedures. Note also that the matrix contains substantial quantitative data rather than
vague statements; this is excellent. Overall, this store receives a 2.5 total weighted score, which on a 1-to-4 scale is exactly
average/halfway, indicating there is definitely room for improvement in store operations, strategies, policies, and procedures.”