United States General Accounting Office

GAO Testimony

Before the Subcommittee on Military Readiness,

Committee on National Security, House of Representatives

For Release on Delivery

Expected at

2 p.m.

Tuesday,

July 22, 1997

DEFENSE WORKING

CAPITAL FUNDS

DOD Faces Continued

Challenges in Eliminating

Advance Billing

Statement of Jack L. Brock, Jr.

Director, Defense Information and Financial Management

Systems

Accounting and Information Management Division

GAO/T-AIMD/NSIAD-97-221

Mr. Chairman and Members of the Subcommittee:

We are pleased to be here today to discuss the Department of Defense’s

(DOD) working capital funds, formerly known as the Defense Business

Operations Fund (DBOF), which both collect and disburse over $65 billion

annually. Specifically, our testimony will provide a (1) brief overview of

fund operations and objectives, (2) a more detailed perspective of cash

management operations, and (3) our concerns with the cash situation

through fiscal year 1998.

Working Capital

Funds

In 1991, the Department established DBOF in order to foster a more

business-like culture within selected Defense operations—including depot

maintenance, transportation, supply management, and finance and

accounting. In creating DBOF, DOD consolidated the nine existing industrial

and stock funds operated by the military services and Defense

components into a single financial structure. The military services and

Defense components continued to be responsible for managing and

operating business activities within the financial structure. In late 1996, the

Under Secretary of Defense (Comptroller) reorganized DBOF and created

four working capital funds: Army, Navy, Air Force, and Defense-wide. This

was done in order to clearly delineate the responsibilities of the military

services and Defense components for managing the functional and

financial aspects of their respective business areas. The recently

established working capital funds continue to operate the same way they

did under DBOF.

The primary goal of the working capital funds is to focus the attention of

all levels of management on the total costs of carrying out certain critical

DOD business operations and the management of those costs in order to

encourage support organizations, such as depot maintenance facilities, to

provide quality goods and services at the lowest costs. Focusing attention

on costs is important, given the size of the working capital funds. For

fiscal year 1998, the four funds are expected to generate about $69 billion

in revenue and employ about 220,000 civilians and 24,000 military

personnel.

The working capital funds are supposed to generate sufficient revenues to

recover expenses incurred in their operations and to operate on a

break-even basis over time. Essentially, each business area establishes

prices prior to the start of each fiscal year and applies these

predetermined (stabilized) prices to most orders and requisitions received

Page 1 GAO/T-AIMD/NSIAD-97-221
during the year. Prices reflect expected workload (based on customer

input), costs of labor and material, and productivity projections. To the

extent these estimates are accurate, revenues should cover cost.

Higher-than-expected costs or lower demand can lead to losses while the

converse can lead to profits. Since the funds are to operate on a

break-even basis over time, profits effectively reduce prices in later years

while losses result in higher prices or surcharges.

To date, the working capital funds have not yet accomplished their goal of

operating on a break-even basis and DOD estimates that they will have an

accumulated operating loss of $1.7 billion at the end of fiscal year 1997.

Over the last several years, various congressional Defense oversight and

appropriations committees have expressed concern with these losses and

the management and operations of the funds. To address these concerns,

Defense was required to conduct a study of its working capital funds as

directed in the National Defense Authorization Act for Fiscal Year 1997.

Not later than September 30, 1997, the Secretary of Defense is required to

submit to the Congress a plan to improve the management and

performance of the industrial, commercial, and support type activities that

are currently managed in the working capital funds.

We remain very supportive of the concept behind the working capital

funds. We believe the funds, even under DBOF, have achieved a measure of

success because they are doing a better job of identifying the costs of

doing business and including those costs in the prices charged to

customers. This gives DOD managers a window into the costs of Defense

support operations—including costs for direct labor, material, overhead,

and contracts. With a more complete cost picture, managers can account

for past activities, manage current operations, and assess progress toward

planned objectives. In addition, more accurate identification of costs

enables those responsible for providing oversight to make more informed

policy decisions by highlighting the cost associated with those decisions.

We are hopeful that DOD will use its forthcoming plan as a mechanism to

continue to strengthen its commitment to improving the management and

operations of the working capital funds as well as identifying the total

costs of providing goods and services to customers and including those

costs in the prices charged customers.

Working Capital Fund

Cash Management

Since 1993, the working capital funds have experienced a cash shortage

and have had to advance bill customers for work not yet performed in

order to ensure that the funds’ cash balances remain positive. In

Page 2 GAO/T-AIMD/NSIAD-97-221
February 1995, DOD devolved the responsibility for cash management to

the military services and the Defense components to better align

accountability and responsibility for management; however, advance

billing continues and may well continue through the next fiscal year.

The Importance of Cash

for Working Capital Funds

Cash plays an extremely important role for DOD’s working capital funds.

Cash generated from the sale of goods and services is the primary means

by which the working capital funds pay their bills. Where the cash

balances start each year depends on the outcome of many decisions made

during the budget process with regard to (1) projecting workload,

(2) estimating costs, and (3) setting prices to recover the estimated full

cost of the goods and services. During the execution of the budget, they

operate much like a checking account: collections increase the funds’

account balances and disbursements (such as salaries and purchases of

inventory) reduce the account balances. To the extent that the decisions

made during the budget process are reasonably accurate, the funds’ cash

balances should fall between the minimum and maximum amount required

by DOD. However, if the decisions are not accurate, the funds could have

too much or not enough cash.

DOD’s policy requires the funds to maintain cash levels to cover 7 to 10

days of operational costs and 4 to 6 months of capital asset disbursements,

which is about $2.3 billion to $3.4 billion for the four funds. If the level of

cash becomes low and there is a possibility of incurring an Antideficiency

Act1

 violation, immediate actions will be taken to resolve the cash

shortages by advance billing customers.

When DBOF was established, DOD consolidated the cash balances of the

nine industrial and stock funds into a single account that was managed

centrally by the Office of the Secretary of Defense (Comptroller). DOD

believed that managing cash at a central level would be more effective.

However, in practice this did not work as expected, and, in February 1995,

DOD devolved responsibility for cash management as well as Antideficiency

Act responsibilities to the military services and the Defense components.

According to DOD officials, the cash management responsibility was

devolved to the Army, Navy, Air Force, and Defense components to better

align accountability and responsibility for managing cash. DOD pointed out

that the operational control of actions taken by each fund activity, which

1

The Antideficiency Act, 31 U.S.C. 1341(a)(1) provides that no officer or employee of the government

shall make or authorize an expenditure or obligation exceeding the amount of an appropriation of

funds available for the expenditure or obligation.

Page 3 GAO/T-AIMD/NSIAD-97-221
results in cash disbursements and collections, always has resided and

continues to reside with the individual Defense components.

We agree with DOD’s decision to place the responsibility for managing the

working capital funds’ cash at the military service and Defense component

level and to likewise devolve the Antideficiency Act responsibility.

Decentralized cash management should result in a number of benefits. For

example:

• Decentralization makes each individual Defense component directly

accountable for its respective cash balance as well as its decisions that

affect cash, including any violation of the Antideficiency Act. Each

component now has an incentive to more accurately price the goods and

services that its working capital fund charges customers since inaccurate

prices could lead to insufficient cash to cover daily operating expenses.

• One Defense component cannot spend money generated by another

component. When cash management was centralized, DOD did not have

reports that showed the cash balances for the individual Defense

components—the reports only provided information on (1) DBOF’s overall

cash balance and (2) collection and disbursement data for each of the

Defense components. With the decentralization of cash management, the

Department of the Treasury provides DOD with a cash balance for each of

the five components.

• The Office of the Secretary of Defense (OSD) and the Defense components

have started working more as a team to resolve cash problems. Under

centralized cash management, there was less incentive for the components

to respond to cash problems as OSD had responsibility for maintaining the

balance and for avoiding an Antideficiency Act violation. When the

components became responsible for their individual cash balances, they

raised more questions on the accuracy and timeliness of the information

on collections and disbursements. Such increased attention should help

improve the accuracy of collection and disbursement data reported in the

working capital funds’ financial statements prepared under the Chief

Financial Officers Act of 1990, as expanded by the Government

Management Reform Act of 1994.2

DOD Has Advance Billed

Customers to Alleviate

Cash Shortages

Since 1993—with the transfer of $5.5 billion from DBOF as required by the

National Defense Authorization Act for Fiscal Year 1993—the funds have

been advance billing customers because they have not been able to

2

Since the inception of DBOF in fiscal year 1992, the DOD Inspector General has not been able to

render a favorable audit opinion on the fund’s financial statements.

Page 4 GAO/T-AIMD/NSIAD-97-221
generate enough cash to pay their bills. In July 1994, the Comptroller of

Defense stopped the advance billing at all activities except for the Naval

shipyards and research and development activities, which had been

tentatively scheduled to stop advance billing in January 1995. However,

DOD officials informed us that when the responsibility for cash

management was returned to the components in February 1995, the

amount of cash returned to the services was not sufficient to cover

outstanding DBOF liabilities. DBOF’s financial reports indicate that this was

the case with each service facing cash shortages. Therefore, according to

DOD, it was necessary for the Army, Navy, and Air Force to continue to

advance bill customers so that their cash portion of DBOF would not go

negative.

Since 1995, the military services have made some progress in liquidating

(working off) their outstanding advance billing balances. However, the

Navy and Air Force had to advance bill customers again during calendar

years 1996 and 1997 to ensure that their cash balances remained positive.

Specifically, the Navy advance billed customers about $1.7 billion and the

Air Force advance billed customers $1.2 billion during calendar year 1996.

For calendar year 1997, the Navy and Air Force have advance billed their

customers about $400 million and $695 million, respectively, with most of

the billings occurring in June 1997—$230 million for the Navy and

$565 million for the Air Force. Figure 1 shows (1) the reported cash

balances for the Army, Navy, and Air Force portions of the funds and

(2) cash balances for these components if they did not advance bill their

customers from February 1995—when DOD returned the responsibility for

cash to the military services and Defense components—through May 1997

(the charts in figure 1 only depict data through May 1997 because working

capital fund outstanding advance billing balance data for June 1997 were

not yet available). (The charts in figure 1 are also provided in full-page

view in appendix I.)

Page 5 GAO/T-AIMD/NSIAD-97-221
Figure 1: Working Capital Fund Cash Balances (Dollars in Millions)

Overall Working Capital Fund Army Working Capital Fund 

Cash policy requires about $2.3 billion to $3.4 billion.

2/95 6/95 6/96 12/96 -1,000

0

1,000

2,000

3,000

4,000

5,000

6,000 Cash balance

W/O adv. bill.

5/97

Cash policy requires about $360 million to $515 million.

2/95 6/95 6/96 12/96 -400

-200

0

200

400

600

800 Cash balance

W/O adv. bill.

5/97

Navy Working Capital Fund Air Force Working Capital Fund

Cash policy requires about $625 million to $900 million.

2/95 6/95 6/96 12/96 -3,000

-2,000

-1,000

0

1,000

2,000

3,000 Cash balance

W/O adv. bill.

5/97

Cash policy requires about $465 million to $670 million.

2/95 6/95 6/96 12/96 -400

-200

0

200

400

600

800

1,000

1,200 Cash balance

W/O adv. bill.

5/97

Note: We did not independently verify the financial information shown in the figure, which was

taken from DOD and Treasury reports.

Page 6 GAO/T-AIMD/NSIAD-97-221
As figure 1 shows, the Army, Navy and Air Force would have had negative

cash balances when they received the responsibility for cash in

February 1995 had they not advance billed customers. The figure also

shows the following.

• The three military services have liquidated $4.2 billion of outstanding

advance billings from February 1995 through May 1997. However, because

of Navy and Air Force advance billings in June 1997, we are unsure of the

effect these billings will have on the liquidation on the outstanding

advance billings to date.

• As of May 1997, the outstanding advance billing balance was about

$1 billion. Again, because of Navy and Air Force advance billings in

June 1997, we are unsure of the effect these billings will have on the

outstanding advance billing balances to date.

• The Army has liquidated almost all of its outstanding advance billing

balance.

• The Navy’s cash balance would have been negative for most of the period

from February 1995 through May 1997 if it had not advance billed

customers.

• The Air Force liquidated most of its outstanding advance billing balance

until it again started advance billing customers over a billion dollars in

December 1996 to ensure that its cash balance would remain positive.

According to Army and Air Force officials, they plan to liquidate all their

outstanding advance billing balances by the end of fiscal year 1998. Navy

officials informed us that they now plan to liquidate the Navy’s

outstanding advance billing balance by the end of fiscal year 1999.

Cash Outlook for Fiscal

Years 1997 and 1998

DOD’s cash plans, dated January/February 1997, show that the working

capital funds will disburse about $2.3 billion more than they collect during

fiscal year 1997. To offset most of the cash drain that DOD expects to occur

during fiscal year 1997, DOD plans to increase fiscal year 1998 prices to

recoup losses and generate cash. DOD plans also show that it expects to

collect about $2.2 billion more than it disburses during fiscal year 1998.

This information is summarized in table 1.

Page 7 GAO/T-AIMD/NSIAD-97-221
Table 1: DOD’s Working Capital Fund

Annual Cash Plans Dated

January/February 1997

Dollars in millions

Component

Estimated fiscal year

1997 collections less

disbursements

Estimated fiscal year

1998 collections less

disbursements

Army $ (173.4) $ 27.2

Navy (1,427.7) 984.5

Air Forcea (154.5) 493.4

Defense agencies (511.0) 669.4

Total $(2,266.6) $2,174.5

aAir Force fiscal year 1998 figure includes United States Transportation Command’s net

collections of $102.6 million.

Based on our analysis of cash and outstanding advance billing balances, as

well as past trends, we believe that the Navy and Army may have to

advance bill customers during the remainder of fiscal year 1997 in order to

ensure that their cash balances remain positive. This is primarily because

these services’ recently reported cash balances are below the minimum

required cash level.

Further, as we have previously testified,3

 our review of five working

capital fund business areas and the assumptions used to develop their

fiscal year 1998 prices (which could change as fiscal year 1998

approaches) indicated that the prices for four of the five business areas

may not be high enough to cover estimated fiscal year 1998 operating costs

and eliminate accumulated operating losses by over $300 million. In

developing their fiscal year 1998 prices, our review showed that the

business areas (1) overestimated productivity, (2) set unrealistic

cost-reduction goals, and (3) overestimated workload.

These problems are not unique to the development of the fiscal year 1998

prices. We have previously reported4

 that these problems have been the

primary cause of some business areas reporting operational losses. Until

DOD acts to resolve these problems, some business areas will continue to

incur losses from day-to-day operations, which could impede DOD’s ability

to eliminate the practice of advance billing.

3

Defense Depot Maintenance: Challenges Facing DOD in Managing Working Capital Funds

(GAO/T-NSIAD/AIMD-97-152, May 7, 1997).

4

Air Force Depot Maintenance: Improved Pricing and Financial Management Practices Needed

(GAO/AFMD-93-5, Nov. 17, 1992); Defense Business Operations Fund: Improved Pricing Practices and

Financial Reports Are Needed to Set Accurate Prices (GAO/AIMD-94-132, June 22, 1994); and Navy

Ordnance: Analysis of Business Area Price Increases and Financial Losses (GAO/AIMD/NSIAD-97-74,

Mar. 14, 1997).

Page 8 GAO/T-AIMD/NSIAD-97-221
Mr. Chairman, this concludes our statement. We would be pleased to

answer any questions you or Members of the Subcommittee may have at

this time.

Page 9 GAO/T-AIMD/NSIAD-97-221
Working Capital Fund Cash Balances

(Dollars in Millions)

Figure I.1: Overall Working Capital Fund

2/95 6/95 6/96 12/96

-1,000

0

1,000

2,000

3,000

4,000

5,000

6,000 Cash balance

W/O adv. bill.

5/97

Note: Cash policy requires about $2.3 billion to $3.4 billion.

Page 10 GAO/T-AIMD/NSIAD-97-221
Working Capital Fund Cash Balances

(Dollars in Millions)

Figure I.2: Army Working Capital Fund

2/95 6/95 6/96 12/96

-400

-200

0

200

400

600

800 Cash balance

W/O adv. bill.

5/97

Note: Cash policy requires about $360 million to $515 million.

Page 11 GAO/T-AIMD/NSIAD-97-221
Working Capital Fund Cash Balances

(Dollars in Millions)

Figure I.3: Navy Working Capital Fund

2/95 6/95 6/96 12/96

-3,000

-2,000

-1,000

0

1,000

2,000

3,000 Cash balance

W/O adv. bill.

5/97

Note: Cash policy requires about $625 million to $900 million.

Page 12 GAO/T-AIMD/NSIAD-97-221
Working Capital Fund Cash Balances

(Dollars in Millions)

Figure I.4: Air Force Working Capital Fund

2/95 6/95 6/96 12/96

-400

-200

0

200

400

600

800

1,000

1,200 Cash balance

W/O adv. bill.

5/97

Note: Cash policy requires about $465 million to $670 million.

(511633, 709289) Page 13 GAO/T-AIMD/NSIAD-97-221
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