Operational Profitability: Conducting Management Audit

Operational Profitability: Conducting Management Audit

by Robert M. Torok, Patrick J. Cordon


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Product Details

ISBN-13: 9780471172253
Publisher: Wiley
Publication date: 01/28/1997
Pages: 272
Product dimensions: 7.24(w) x 10.24(h) x 0.94(d)

About the Author

ROBERT M. TOROK, CPA, is Vice President of the accounting firm of Zalick, Torok, Kirgesner, Cook & Co. in Cleveland, Ohio.

PATRICK J. CORDON is a Registrar Accreditation Board/International Re-gister of Certificated Auditors/Auto-motive Industry Action Group lead auditor at Omnex-Automotive Quality Systems Registrar Inc.

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Note: The Figures and/or Tables mentioned in this chapter do not appear on the web.


It is important to note that, unlike the financial and operational analysis, which are limited in both scope and objectives, the management analysis is broader in its approach and objectives. The purpose of the broad approach in this manual is to allow flexibility throughout the course of the management analysis, since the specific problems have usually not been defined beforehand.

The professional management analysis will require various types of skills on the part of the individual or individuals involved. They should possess the ability to communicate effectively with all levels of the organization and to maintain a thought process that can critically evaluate each aspect of the organization. The management analysis approach will cross over various functions and management levels, and will require a basic knowledge of different disciplines.

The management analysis audit approach should follow certain basic steps for each engagement, even though the objectives of the various analysis will vary. The findings must be supported by facts and documented evidence. Each analysis should include the following features:

  • Definition of project scope. Both upper management and the staff conducting the analysis must be in total agreement on the overall scope of the project. In some instances, the management analysis may be general in scope and the audit will include a detailed appraisal of each operational aspect of the organization. In other instances, a specific problem area may be defined (for example, the quality of the company's main product may be found lacking), and the management analysis will be initiated to document the causes and recommend corrective actions.

  • Planning, preparation, and organization. When the project scope has been defined, the management analysis team will develop an action plan for conducting the assignment. The action plan documents the steps to be followed and estimates the time required to accomplish each step. This stage of the management analysis requires that each source of documentation relating to the area under review is thoroughly analyzed and updated.

  • Fact gathering and documentation update. The next general phase of the management analysis includes the accumulation of all informational data relating to the areas defined in the scope of the project. This data is obtained from correspondence, policies and procedures, and all other informal information which can be obtained directly from employees through interviews.

  • Research and analysis. The research and analysis stage is the most critical in the management analysis process. This phase of the audit accumulates the evidence and the facts which are necessary to support a final report to upper management.

  • Reporting. The reporting phase of the management analysis includes a summarization of the work that was conducted, a description of the scope of the project, a detailed account of the major findings and a discussion of the alternatives which are available to upper management for eliminating the problem conditions which exist.

When the company is entering a period of new growth or major change, a management analysis can be useful to help set priorities for management attention.


A full management analysis is a detailed survey of the entire business. For ease in assigning data collection and analysis, the checklist has been organized into 14 topics:

1. Background of the business, current problems, and outlook;

2. Ownership, capital structure, and investment policy;

3. Strategic concepts and competitive positioning;

4. Financial condition performance, and accounting;

5. Products (services), markets, and distribution;

6. Sales and marketing;

7. Operating policies, methods, and controls;

8. Manufacturing, inventory controls, and engineering;

9. Technical capabilities and development;

10. Organization, personnel, management development, and legal;

11. Purchasing;

12. Management systems, controls, and effectiveness;

13. Data processing; and

14. Special audits.

This checklist covers an in-depth analysis. A complete, but less detailed audit can be completed by using the same checklist only as a general guide.


Every company is different. Every management analysis is different. It is not possible to say exactly how much work is involved in a typical analysis. However, as a general estimate, an outside consultant might spend several person-months auditing a $10Ð$ 20-million company. The same consulting firm might commit several person-years to an audit of a billion-dollar corporation.

Following are some important factors that influence how much effort is required for analyzing a particular firm:

  • Company size and structure;
  • Complexity of market and product lines;
  • Customer geography and distribution channels;
  • Diversity of facilities;
  • Material control requirements;
  • Technical base of operations; and
  • Information needs for control.


In preparing to carry out a self-conducted management analysis, a company should first determine whether it needs a full analysis or wants to focus only on one or more of the major topics. This will help determine who in the organization is most appropriate to be assigned to this project and how much effort will be required.

Management should then establish specific timetables for collecting basic data as well as a schedule for obtaining answers to those questions that will involve discussion with managers and others in the organization. These timetables will help control the total effort and will, of course, influence the depth of the audit. As the audit proceeds, these schedules should be reviewed to find out if they are too tight to obtain all the information required, or if they are so loose as to allow the audit to consume too much time.

After the schedules are established and personnel identified, there should be a discussion of the analysis, its purposes, its schedules, and participants, with all members of the management staff. It is important that everyone understand what the project means, and the value of the project in improving their effectiveness and in enhancing the performance of the company. Their participation and their honest input will be critical. As the project proceeds, frequent input from the participants is essential, as is that of management staff and others in the organization regarding how well participants are performing in gathering information.

Trends in the data and weaknesses in the answers will reveal issues for further study. The answers not obtained are often more important than the answers that are. Lack of response will often point to the priority of the information collected and those items requiring action should be addressed.

It is important that all information collected is well documented, as even apparently unimportant papers and notes may be valuable in the analysis. They certainly will be necessary if there is a need to go back and check the information. They will also be helpful in the next audit to show what changes have occurred. Some historical data will not have to be collected next time.

The checklist is not perfect. It is oriented toward manufacturing firms, but is still useful for many other types of businesses. It can never be complete in its application to any one particular business.


Following is a synopsis of how to determine goals and expectations.

Goal A means of establishing: what you want; when you want it; and how you want it.

Expectation A means of communicating to others those goals you expect to be accomplished. It is a means of diminishing assumptions as to what one perceives things to be versus what others perceive things to be.

There are seven parts to consider when preparing Goals/ Expectations:

1. Increase output, yield, equipment utilization, or other quantity of work;

2. Reduce costs such as for scrap, rework, personnel turnover, absenteeism, learning time, overtime, down time, maintenance, and supplies;

3. Obtain more suggestions for improving methods and procedures;

4. Reduce the number of rejects and complaints from inspection;

5. Complete a specific project by a certain deadline;

6. Develop trained replacements for specific jobs; and

7. Reduce medical aid, lost time, accidents, or employee grievances.


Forecasting provides management with the ability to establish realistic goals based on plant capabilities and current requirements. Crew levels can be determined by the volume that is planned to be produced. This determination is used to create a more uniform production schedule, thus eliminating large production imbalances.


The purpose of the planning phase is to put manpower, materials, and machinery together in a coordinated effort to produce the required amount of production for each production period.


Execution provides management with ability to assign work schedules on a daily basis, as well as provide a means to monitor throughout each shift to ensure that the plan is being attained and to react immediately to off-schedule conditions and variances in order to minimize lost time and reduce production costs. The means for this activity is provided by the daily/ weekly schedule, activity sheets, and daily schedule review meetings.


Follow-up is the inspection phase of the system. Follow-up is the method that management uses to assure compliance to the plan, to identify problems, and initiate corrective action. It is a tool that will enable subordinates to feel secure that, if a problem develops, their management cares enough to be there to do something about it. It is a deterrent to creating perception problems between management and management; and management and labor. Follow-up is the assurance that the Execution phase is going as planned. Effective follow-up makes reporting a postmortem activity.


Reporting will provide all levels of management with the current results of the day's accomplishments against the plan, so that effective steps can be taken to correct off-schedule conditions and to realistically plan the next production period. Reporting provides an avenue of communication between all levels of management, to discuss the results of the day's progress and the goals to be established for the next production period. Reporting assures that problem areas are highlighted and necessary decisions are made to resolve the problem.


Evaluation is a method of determining why something happened. It is an analysis conducted after results are reported, so that future activities can better be forecasted and planned. Evaluation occurs by thoroughly analyzing reporting documents. Overall performance is compared against plan. Specifically, we evaluate to determine:

  • How costs were distributed (i. e., set-up, down time, changeovers, etc.);
  • Where costs are higher than at other times;
  • Why costs were higher one day than another;
  • What can be done to achieve the same performance level as achieved on good days;
  • Who is performing well and who isn't;
  • What corrective action has occurred to solve negative variances;
  • What corrective action is still required; and
  • Where, when, and why lost time occurred.

In summary, evaluation is the important process dissecting past activities and performance, so that processes, procedures, and behaviors can be modified for future requirements.


The following system concepts have different manager characteristic efficiency requirements.


  • Evaluates work openly and honestly;

  • Accepts criticism as a basis for improvement;

  • Sees the future as something one makes happen, not something that just happens;

  • Judges ideas on the basis of merit, not on the basis of origin;

  • Does not deny or excuse waste, inefficiency, or lost time;

  • Sees the work of the department in relation to the larger organization.


  • Sees the future as something one makes happen, not something that just happens;

  • Judges ideas on the basis of merit, not on the basis of origin;

  • Assigns work with due regard to production need and worker capabilities, rather than on personal biases, seniority, or custom;

  • Delegates jobs and responsibilities to those who are subordinate;

  • Defines goals, standards, and expectations for workers. Holds oneself and others to high, though realistic, goals;

  • Is productivity-oriented and cooperates with new procedures to increase productivity.


  • Assigns work with due regard to production need and worker capabilities, rather than on personal biases, seniority, or custom;

  • Delegates jobs and responsibilities to those who are subordinate;

  • Defines goals, standards, and expectations for workers. Holds oneself and others to high, though realistic, goals;

  • Rejects unthinking obedience as an appropriate work orientation;

  • Avoids judgmental thinking; does not judge co-workers on the basis of sex, race, or appearance;

  • Relates to workers with consideration and understanding.


  • Sees worker alienation and its manifestations (absenteeism and turnover) as something that can be influenced through more effective supervision;

  • Follows-up on work assignments to assure adequate performance;

  • Communicates positive and negative feedback as appropriate; Confronts and counsels with employees when their work does not meet standards;

  • Encourages workers to see themselves as members of a team, with each worker contributing to the achievement of team goals; Takes responsibility for developing stronger worker morale and motivation;

  • Recognizes that people do their best work when they feel a sense of involvement.


Lost time is nonproductive time. Lost time occurs whenever time that was designated to be used in the active production of a product or the delivery of a service is used for something else. Simply stated, lost time is any time that is used for some other activity other than accomplishing a production goal.

Lost time occurs for many different reasons but can generally be traced back to one of three points of origin:

  • People problems;
  • Machine problems; or
  • Material problems.

These problems result from poor planning, ineffective communication, or lack of follow-up and confrontation.

Lost time prevents managers from meeting their goals. Lost time increases the cost of the product and, consequently, has a negative effect on the profit that the manager is expected to "earn" for the company.

Managers have the responsibility to:

  • Recognize lost time;

  • Identify its causes;

  • Take corrective action to eliminate or minimize lost time; and

  • Monitor actions to assure the steps taken have eliminated lost time.

Recognizing Lost Time and Identifying Causes

Some lost time is easy to recognize (i. e., material shortages, mechanical breakdowns, people loafing, or extending break periods). This is known as obvious lost time. Other lost time is more subtle, or hidden. Examples of this are "pacing" on the part of the workers, duplication of effort, undertrained employees, or lack of discipline. In order to help you become more effective in recognizing and identifying lost time and its causes, this book contains a list of things to look for in the work area.

Controlling Lost Time

Once a manager has recognized that lost time has occurred in a work area and has identified those factors that have caused it to occur, he or she must take corrective action to eliminate the cause. The manager becomes a problem solver and a decision maker. As will be seen in the next section, it is the manager who is sometimes the cause. This means that in some situations, in order to eliminate lost time, the manager must consider one's own behaviors and performance as a manager and set upon a course that will ultimately result in changing those behaviors. The passive manager, the manager who fails to set and communicate goals, the manager who fails to use or comply to systems, the manager who resists change, and the manager who does not use internal motivational techniques with people tends to have more lost time than managers who are more active and have a more positive outlook on their role and function.

Controlling lost time is not always easy, because hidden lost time occurs right in front of us. We must change our perceptions if we are to be able to recognize the symptoms and the cause of lost time. Lost time is the single greatest obstacle the manager faces to increasing productivity. Nonetheless, the effective manager must take the responsibility for eliminating lost time so that the goals of the company are met.

Table of Contents

The Basic Approach.

Building the Organization from the Bottom Up.

Financial Ratio Analysis.

Impact of the Seven Causal Ratios on the Nine Secondary Ratios that Measure Effect.

Cash Flow and Break-Even Analysis.



Operations Efficiency Measures.

Reducing Operating Costs.

Inventory Controls.

Production Planning and Control.


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