Army Working Capital Fund: Army Faces Challenges in Managing Working Capital Fund Cash Balance during Wartime Environment
Published: 2010-06-22T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Army Working Capital Fund (AWCF) collected over $16 billion for goods and services provided to customers in fiscal year 2009. Cash generated from sales is used by AWCF to cover its expenses such as paying employees. In light of the Army's changing role in the Middle East, GAO was asked to determine whether (1) AWCF's monthly cash balances fell within the Department of Defense's (DOD) cash requirements for fiscal years 2000 through 2009, (2) the cash transfers resulted in AWCF's monthly cash balances falling below the minimum amount required by DOD, and (3) the AWCF's projected monthly cash balances are expected to fall below DOD's minimum cash requirement for fiscal years 2010 and 2011 and actions the Army can take to manage those balances. To address these objectives, GAO (1) reviewed relevant DOD guidance, (2) obtained and analyzed AWCF budget and accounting reports containing cash information, and (3) interviewed DOD and Army officials.
section_title: What GAO Found
paragraphs: GAO analysis showed that the AWCF monthly cash balance fluctuated significantly between fiscal years 2000 and 2009 and exceeded the maximum cash requirement prescribed by DOD regulation for 94 out of 120 months. The fluctuations were due to differences between receipts and disbursements, including the (1) receipt of collections from AWCF operations, (2) appropriations received in support of the wars, (3) disbursements made to pay for AWCF expenses, and (4) transfers made to fund other Army requirements. The Army transferred $4.8 billion out of AWCF from fiscal years 2004 through 2009. Most of the transfers funded requirements of Operation Iraqi Freedom, Operation Enduring Freedom, or military personnel costs. These transfers helped to reduce the cash balance, but also resulted in the AWCF cash falling below the minimum cash requirement for a 6-month period in fiscal year 2006. GAO analysis of the AWCF fiscal year 2011 budget and cash plan showed that the projected monthly cash balances for fiscal years 2010 and 2011 would exceed DOD's minimum cash requirement for 22 out of 24 months. While the Army does not expect a cash shortfall due primarily to an increase in military build-up activities in Afghanistan, a cash shortfall may occur if certain Army actions are not implemented and monitored effectively. These actions include (1) reducing AWCF obligations to less than the amount of inventory sold, (2) collecting funds from Defense Logistics Agency (DLA) for inventory items transferred from AWCF to DLA, and (3) reducing the amount of inventory at industrial operations activities. Further, the relevant DOD Financial Management Regulation lacks sufficient clarity to determine the appropriate level of inventory to be held at these activities.

section_title: Letter
paragraphs: The Army Working Capital Fund (AWCF) collected over $16 billion in  fiscal year 2009 through (1) selling spare and repair parts needed by its  customers, primarily Army operating units and depots; (2) repairing and  upgrading equipment such as the Army’s Apache helicopter and M1  Abrams tank; and (3) producing weapons and munitions. AWCF supports  the combat readiness of Army units operating worldwide, especially in  Iraq and Afghanistan. AWCF generates revenue by billing customers at  predetermined, fixed prices as AWCF performs specifically agreed-upon  work for those customers. AWCF customers primarily use their  appropriated funds to pay for the work, and AWCF’s income from the sale  of the goods and services is then used to fund continuing operations. Cash  generated from the sale of goods and services is the primary means by  which AWCF meets its financial obligations, such as paying its civilian  employees and purchasing needed materiel to sustain continued  operations.
The availability of sufficient cash in AWCF depends on the outcome of  many decisions made during the Department of Defense’s (DOD) budget  process with regard to (1) projecting workloads, (2) estimating costs, and  (3) setting prices to recover the estimated full cost of goods and services.  The cash account balances are directly affected by collections from the  sale of goods and services; disbursements (such as salaries and purchases  of inventory); appropriations from Congress; and transfers in and out of  the AWCF. According to the DOD Financial Management Regulation,  “cash levels should be maintained at 7 to 10 days of operational cost and  six months of capital disbursements,” (hereafter, referred to as the cash  requirement). If the cash balance becomes negative, the Army could incur  an Antideficiency Act violation. If AWCF builds excess cash balances, it is  subject to either budget cuts from DOD or Congress or transfers from  AWCF to other Army activities.
As requested and agreed to with your office, our objectives were to  determine whether (1) AWCF monthly cash balances fell within DOD’s  cash requirements for fiscal years 2000 through 2009, (2) the cash transfers  for fiscal years 2000 through 2009 resulted in the AWCF’s monthly cash  balances falling below the minimum cash requirement, and (3) AWCF’s  projected monthly cash balances are expected to fall below the minimum  cash requirement for fiscal years 2010 and 2011, and actions the Army can  take to manage those balances.
Financial information in this report was obtained from official Army  budget documents and accounting reports. To assess the reliability of the  data, we (1) obtained and analyzed reports containing detailed data on  transactions affecting the AWCF cash balance including collections,  disbursements, direct appropriations to the AWCF, and funds transferred  in or out of the AWCF; (2) obtained an understanding of the process used  by the Defense Finance and Accounting Service to reconcile Army cash  balances with Department of the Treasury records; (3) reconciled year-end  cash balances between Army reports and Treasury records; and                 (4) obtained and analyzed documentation supporting the amount of funds  transferred out of the AWCF. On the basis of procedures performed, we  have concluded that these data were sufficiently reliable for the purposes  of this report.
Further details on our scope and methodology are provided in appendix I.  We conducted this performance audit from June 2009 through June 2010 in  accordance with generally accepted government auditing standards. Those  standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  conclusions based on our audit objectives. We believe that the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives. We requested comments on a draft of this  report from the Secretary of Defense or his designee. Written comments  from the Office of the Under Secretary of Defense (Comptroller) are  reprinted in appendix II.
subsections: section_title: Background
paragraphs: AWCF consists of two activity groups: industrial operations and supply  management. The Army industrial operations activity group provides the  Army with the in-house capability to conduct depot-level maintenance,  repair, and upgrade; produce quality munitions and large-caliber weapons;  and store, maintain, and demilitarize materiel (equipment and supplies) for  all branches of DOD. To perform its mission, the industrial operations  activity group employed 26,200 civilian personnel who, according to the  AWCF budget, performed approximately 31.1 million hours of direct labor  in fiscal year 2009. As figure 1 illustrates, the industrial operations  activities receive orders from customers to perform work. Customers  primarily use appropriated funds to finance orders placed with the  industrial operations activities. When industrial operations activities  accept customer orders, the customers’ appropriations are obligated by  the amount of the orders. The industrial operations activities then incur  costs, such as materiel and labor costs as the work is performed, and  disburse funds to cover those costs. The industrial operation activities  then bill the customers for the work performed.
The Supply Management Activity Group buys and manages spare and  repair parts for sale primarily to Army operating units located worldwide  and the Army industrial operations activity group. According to AWCF’s  fiscal year 2011 budget, the supply group employed 3,000 civilian  personnel and managed 119,000 inventory items, received 1.1 million  requisitions from customers, and awarded 13,550 contracts in fiscal year  2009. As illustrated in figure 2, in anticipation of customer needs, supply  (1) buys new inventory items or (2) places orders with contractors and  DOD depot maintenance activities to repair existing inventory items. In  some cases, supply enters into contracts over a year in advance because of  the lead time required to obtain the inventory items. When supply receives  the items, it pays the vendors for those items. Customers primarily use  appropriated funds to finance the purchases of the inventory items from  supply. Supply provides the inventory items to the customers and bills the  customers for the items. Supply uses the payments from customers to  replenish the inventory sold to customers.
A critical function for AWCF is cash management. Effective cash  management is largely dependent on Army managers receiving accurate  and timely data on AWCF cash balances, collections, disbursements, and  projections of anticipated activity. According to DOD’s Financial  Management Regulation, Volume 2B, chapter 9, AWCF is to maintain the  minimum cash balance necessary to meet both operational and  disbursement requirements in support of the capital asset program. AWCF  is to maintain a minimum cash balance sufficient to cover expenses, such  as paying (1) employees for repairing aircraft, weapon systems, and  equipment; and (2) vendors for inventory items. Currently, DOD’s  regulation states that “cash levels should be maintained at 7 to 10 days of  operational cost and cash adequate to meet six months of capital  disbursements.” Thus, the minimum cash requirement consists of cash  that is sufficient to meet 6 months of capital requirements plus 7 days of  operational costs. The maximum cash requirement consists of 6 months of  capital requirements plus 10 days of operational costs. The regulation  further provides that a goal of AWCF is to minimize the use of advance  billing of customers to maintain cash solvency unless required to avoid  Antideficiency Act violations.
Cash generated from the sale of goods and services is AWCF’s primary  means of maintaining an adequate level of cash to sustain its operations.  The ability to generate cash consistent with DOD’s regulation is dependent  on (1) accurately setting prices to recover the full costs of producing  goods and services; (2) accurately projecting workload, such as the  number of tanks, missiles, and helicopters to be repaired during the year;  and (3) meeting established operational goals. If projections of cash  disbursements and collections indicate that cash balances will drop below  prescribed levels, AWCF can generate cash by adding a surcharge to one  or more of its activity groups’ sales prices. In addition, if the cash balance  becomes too low and there is a possibility of an Antideficiency Act  violation, AWCF can raise additional cash by advance billing customers for  work not yet performed. Conversely, if the cash balances are too high,  DOD or the Secretary of Defense, under specific statutory authority, or  Congress can transfer the unneeded funds to other appropriations to  either reduce budget requests or finance additional requirements.
section_title: AWCF Monthly Cash Balance Fluctuated Significantly but Generally Remained above the Maximum Cash Requirement
paragraphs: Our analysis of AWCF cash data showed that the AWCF monthly cash  balance fluctuated significantly between fiscal years 2000 and 2009, but  that it has generally remained above the maximum cash requirement. Over  the 10-year period, the fluctuations were due to AWCF (1) collecting      $1.7 billion more than it disbursed for several reasons, including  experiencing significantly higher sales volume at the beginning of the war  in Iraq, (2) receiving $3.9 billion in appropriations primarily to cover war- related expenses, and (3) transferring $4.8 billion out of AWCF to pay for  other requirements such as Operation Iraqi Freedom (OIF). AWCF was  over the maximum cash requirement for 94 of the 120 months, between  the minimum and maximum cash requirements for 7 of the 120 months,  and under the minimum cash requirement for 19 of the 120 months. Figure  3 shows the AWCF monthly cash balance compared with the minimum  and maximum cash requirements for the 10-year period.
Following is a chronological analysis of the fluctuations in the cash  balances from September 30, 1999, through September 30, 2009, and the  reasons for the changes.
subsections: section_title: Cash Balance Declined from September 1999 through September 2002, Driving the Cash Balance below the Minimum Cash Requirement
paragraphs: The Army’s cash balance fell below the minimum cash requirement during  fiscal years 2001 and 2002, as illustrated in figure 3. During this period, the  Army had difficulty maintaining cash balances because of diminished cash  flows. The cash balance fell from $533 million on September 30, 1999, to  its lowest point on December 31, 2001, at $14 million. AWCF officials and  financial documentation attributed the reduction to two factors. First, to  return accumulated operating results (gains) to its customers, the Army  lowered the Supply Management Activity Group’s prices by 4.2 percent in  fiscal year 2001 and 2.5 percent in fiscal year 2002. This action reduced  AWCF collections for the 2-year period. Second, AWCF paid a $92 million  settlement for back pay (for asbestos environmental differential pay) at  the Corpus Christi Army Depot. This action increased AWCF  disbursements. As a result, the Army advanced billed its depot  maintenance and ordnance activity groups’ customers $200 million in  fiscal year 2002 to increase the cash balance of the AWCF.
section_title: Cash Balance Increased Significantly from September 2002 through February 2004, Causing Cash Balance to Exceed Maximum Cash Requirement
paragraphs: Beginning in fiscal year 2003, the cash balance in AWCF changed  dramatically with the build-up and execution of the war in Iraq. Between  September 30, 2002, and February 29, 2004, (17 months), the cash balance  increased from $251 million to $2.1 billion—exceeding the maximum cash  requirement. AWCF officials and financial documentation pointed to two  primary factors as causes of the increase in the cash balance. First,  Congress appropriated $468 million to AWCF to (1) increase the Supply  Management Activity Group’s inventory, such as war reserve inventory;  and (2) pay for ordnance and the depot maintenance activity group’s fixed  overhead costs for maintaining plant and equipment required by the Army  to meet mobilization and wartime surge capability. Second, collections  exceeded disbursements by $1.4 billion. AWCF officials and Army  documentation provided three reasons for collections exceeding  disbursements.
The Supply Management Activity Group experienced significantly  higher sales volume during fiscal years 2003 and 2004 to support OIF,  which began in March 2003. According to the Army, collections from  sales are generally higher than disbursements for materiel deliveries  during a time of war. This occurred due to a timing difference between  the delivery and payment for long-lead-time materiel (up to                   24 months). As a result, higher sales volume increased receipts, but the  corresponding disbursements for the items being sold were made in  prior periods.
The Supply Management Activity Group implemented a policy of not  providing cash to customers for the value of broken inventory items  returning from Iraq due to higher repair costs associated with (1) the  impact of the desert environment on Army equipment and inventory,  (2) increased wear on components from the high operational tempo,  (3) battle damage sustained in ongoing operations, and (4) longer  times needed to repair damaged or worn out equipment and inventory.
The Supply Management Activity Group increased its prices by           9.2 percent in fiscal year 2003 to recover prior years’ losses. This  action increased collections which in turn increased the AWCF cash  balance.
section_title: Cash Balance Declined Significantly from February 2004 through March 2006, Driving Cash Balance below the Minimum Cash Requirement for a 6-Month Period
paragraphs: From February 29, 2004, to March 31, 2006, (25 months), the AWCF cash  balance fell from $2.1 billion to $130 million due primarily to the Army  transferring funds out of AWCF. These transfers caused the AWCF cash  balance to fall below the minimum cash requirement for a 6-month period  in fiscal year 2006. The Army transferred $2.1 billion out of AWCF during  the 25 months to pay for unfunded operational expenses associated with  Operation Iraqi Freedom/Operation Enduring Freedom. Approximately  $107 million of the amount transferred was directed by Congress. Further  details are presented in the transfer section of this report.
section_title: Cash Balance Increased Significantly from March 2006 through July 2008, Driving Cash Balance above Maximum Cash Requirement for Most of the Period
paragraphs: From March 31, 2006, to July 31, 2008, (28 months), the AWCF cash  balance increased from $130 million to $3.2 billion. This period  represented the largest increase in the cash balance during the 10-year  period of our review. This increase occurred despite a $596 million  transfer out of AWCF to cover other priority programs. According to  AWCF officials and documentation, the increase was due to (1) a series of  appropriations to AWCF ($2.3 billion) to fund the “Global War on Terror”  and other purposes, and (2) AWCF collections exceeded disbursements  by $1.4 billion. AWCF officials and financial documentation pointed to two  factors for the collections exceeding disbursements. First was the Supply  Management Activity Group’s policy of not paying customers for returning  broken inventory items from Afghanistan beginning in fiscal year 2006.  Second, the Supply Management Activity Group experienced higher sales  volume in fiscal years 2007 and 2008 to support surge operations in Iraq  needed to stabilize the country. As was the case in fiscal year 2003, when  the war in Iraq began, cash was generated from a higher sales volume due  to increased wartime operations. This occurred because of the timing  difference between the delivery and payment of its suppliers for long-lead- time materiel needed to replace depleted inventories (up to 24 months)  and collections to support immediate operational demands from on-hand  inventories.
section_title: Cash Balance Declined from July 2008 through September 2009 but Remained above Maximum Cash Requirement
paragraphs: The AWCF’s cash balance declined by over 50 percent from July 31, 2008,  to September 30, 2009, but the monthly cash balance remained above the  maximum cash requirement. The cash balance decreased from $3.2 billion  to $1.3 billion over the 14-month period. Our analysis of financial  documentation showed that two factors primarily caused the decrease.  First, the Army transferred over $2 billion from the AWCF to pay for        (1) unfunded expenses to support Operation Iraqi Freedom/Operation  Enduring Freedom ($800 million), (2) shortfalls in Army personnel  accounts ($400 million), and (3) a shortfall in the fiscal year 2009 Army  operation and maintenance account needed to cover normal operating  expenses ($823 million). Second, AWCF disbursed $409 million more than  it collected during the 14-month period.
section_title: Billions of Dollars Transferred out of AWCF Did Not Result in a Cash Balance below the Minimum Cash Requirement Except for a 6-Month Period
paragraphs: To fund other critical Army requirements, or as directed by Congress, the  Army transferred $4.8 billion out of AWCF from fiscal year 2004 through  fiscal year 2009. Our analysis of Army documentation and financial  reports for the 6 years determined that the transfers did not result in the  AWCF’s cash balance falling below the minimum cash requirement except  for a 6-month period in fiscal year 2006. In fact, for 63 months of the         72-month period the AWCF cash balance was higher than the maximum  cash requirement even though the Army transferred out billions of dollars.  At no time during the 6-year period was AWCF unable to pay its bills  timely due to insufficient cash or required other means to increase the  cash account, such as advance billing of customers for goods or services  ordered. Table 1 provides the amounts and purposes/intended uses of  AWCF cash transfers for the period.
The transfers in fiscal year 2004 and the first transfer in fiscal year 2005  did not reduce the Army’s cash balance below the maximum cash  requirement (see fig. 3). However, in September 2005, the Army  transferred $450 million, which resulted in the AWCF cash balance falling  below the minimum cash requirement during the first 6 months of fiscal  year 2006. Since that time, the AWCF cash balance steadily increased  through July 31, 2008, when the cash balance reached $3.2 billion. From  July 31, 2008, through September 30, 2009, the Army made eight transfers  totaling $2 billion, which contributed to the sharp decline in the cash  balance from $3.2 billion to $1.3 billion at the end of fiscal year 2009 (see  fig. 3). Despite these transfers, the AWCF cash balance remained above  the maximum cash requirement at the end of fiscal year 2009.
According to the AWCF fiscal year 2010 budget, the $4.8 billion in  transfers was used to fund other Army programs. The budget document  noted that the Army considered emerging requirements, the current cash  balance, the collections and disbursements projection, the accumulated  operating results, the size of undelivered orders, and previous transfer  amounts before making the decision to transfer the funds. Army officials  told us that during the 6-year period during which the transfers occurred,  the AWCF cash balance was generally much higher than normal, allowing  the Army to transfer cash from AWCF to cover critical Army requirements.
section_title: For Fiscal Years 2010 and 2011, AWCF- Projected Monthly Cash Balances Generally Exceed the Minimum Cash Requirement
paragraphs: Our analysis of the AWCF fiscal year 2011 budget and cash plan showed  that the projected monthly cash balances are expected to generally exceed  the minimum cash requirement for fiscal years 2010 and 2011 under the  Army’s assumptions. The cash projections differ from those in the fiscal  year 2010 budget, when the Army’s projections indicated a cash shortfall  during fiscal year 2010. The primary reasons for the higher projected cash  balances in the fiscal year 2011 budget were (1) the decision to increase  the size of U.S. forces in Afghanistan by 30,000 troops will likely increase  AWCF sales and cash collections, and (2) the Army has planned actions  that are expected to increase AWCF collections and decrease  disbursements. These actions include improved inventory management  practices and the Army’s decision not to return gains to customers through  reduced prices.
subsections: section_title: The Army Expects the AWCF Will Have Sufficient Cash in Fiscal Years 2010 and 2011 Due to Higher Sales Supporting Operations in Afghanistan
paragraphs: The Army expects that the AWCF will have sufficient cash in fiscal years  2010 and 2011 due to higher AWCF sales supporting operations in  Afghanistan without resorting to cash surcharges or advance billing  customers for work yet to be performed. The AWCF’s fiscal year 2011  budget and cash plan show that projected monthly cash balances for fiscal  years 2010 and 2011 are expected to be above the minimum cash  requirement for 13 of the 24 months. However, using the current DOD  guidance, our analysis shows that the Army’s projected cash balance is  expected to be above the minimum cash requirement for 22 out of             24 months. Army officials informed us that they did not use current DOD  guidance to calculate the minimum and maximum cash requirements for  presentation in the fiscal year 2011 budget. Instead, they used a proposed  methodology identified during a study DOD is performing to address  congressional concerns regarding the cash requirement. This study is not  yet completed. Figure 4 shows the AWCF’s projected monthly cash  balances for fiscal years 2010 and 2011 and the minimum cash  requirements according to the fiscal year 2011 AWCF budget and current   and current  DOD regulation.  DOD regulation.
The Army’s cash projections in the fiscal year 2011 budget are significantly  different than the cash projections in the fiscal year 2010 budget. The  AWCF’s year-end projected cash balances for fiscal years 2010 and 2011  are expected to be $876 million and $632 million, respectively (see fig. 4).  The $876 million projected cash balance for fiscal year 2010 in the fiscal  year 2011 budget is $362 million higher than the previously projected    $514 million balance for fiscal year 2010 in the fiscal year 2010 budget.
The AWCF’s projected cash balance increased for fiscal year 2010 because  the current administration decided to increase troop levels by about 30,000  in Afghanistan. The increase in troop level is expected to result in  additional sales and thus collections by the AWCF Supply Management  Activity Group through fiscal year 2011. AWCF assumptions contained in  the fiscal year 2011 budget for fiscal years 2010 and 2011 follow:    The fiscal year 2011 budget assumes reduced troop strength and lower  operational levels for OIF. The Army estimates that OIF’s operational  tempo for fiscal years 2010 and 2011 at 33 percent of fiscal year 2009  levels. This decrease in tempo is expected to result in reduced sales  and collections by the AWCF Supply Management Activity Group.
The fiscal year 2011 budget assumes increased troop strength and  higher operational levels for OEF. The Army estimates that OEF’s  operational tempo will increase by 50 percent for fiscal years 2010 and  2011 over the fiscal year 2009 level. The increase in the AWCF Supply  Management Activity Group sales supporting OEF should partially  offset the reduction in sales supporting OIF.
The fiscal year 2011 budget assumes the AWCF industrial operations  activity group will continue to operate at historically high levels of  production in order to reset equipment returning from the current  conflicts. The fiscal year 2011 budget projects total direct labor hours  to remain about 31 million for work performed by AWCF industrial  operations activities.
section_title: Army Actions Are Aimed at Increasing the AWCF Cash Balance to Avoid Potential Shortfalls
paragraphs: Army headquarters officials informed us that they do not anticipate an  AWCF cash shortage in fiscal years 2010 and 2011 due to increased troop  levels in Afghanistan and four management actions under way that are  aimed at increasing collections or decreasing disbursements. The actions  are (1) limiting the AWCF Supply Management Activity Group’s  obligations to less than the total amount of inventory sold to customers,  (2) reducing the AWCF industrial operations’ inventory, (3) collecting  funds from the Defense Logistics Agency (DLA) for consumable inventory  items transferred from AWCF to DLA, and (4) retaining the AWCF’s  accumulated gains instead of returning the amounts to customers. While  Army officials expect the management actions to help AWCF avert  potential shortfalls in fiscal year 2010 and beyond, the success of these  actions will largely depend on how well the actions are implemented and  monitored. These actions are discussed below.
subsections: section_title: Limiting the Supply Management Activity Group’s Obligations to Less Than the Total Amount Sold Generates Cash
paragraphs: In the AWCF fiscal year 2010 budget, the Army projected a unit cost ratio  (obligations to sales) of 1.0 for fiscal years 2009 and 2010. After the fiscal  year 2010 budget was issued in May 2009, we discussed with Army  headquarters officials the unit cost ratio of 1.0 and the effect that it has on  inventory and disbursements that affect future cash balances. During these  discussions, an Army official acknowledged that the unit cost ratio for  these fiscal years needed to be adjusted. In response to the announcement  that U.S. troops would be out of Iraq by December 2011, resulting in  reduced future inventory sales, the Army lowered the unit cost ratio to  0.88, 0.90, and 0.89 for fiscal years 2009, 2010, and 2011, respectively, in its  AWCF fiscal year 2011 budget. By lowering the unit cost ratio, the AWCF  Supply Management Activity Group (1) obligates fewer funds to buy or  repair inventory than the dollar amount of inventory sold to its customers,  and (2) reduces its disbursements. On the basis of the reduced unit cost  ratio, AWCF expects to reduce disbursements by $970 million over fiscal  years 2009 and 2010. Lowering the unit cost ratio indicates a consistent  goal by the Army to manage inventory in relation to the projected  declining sales volume. Army officials informed us that as leadership  decisions unfold in a wartime environment, the projections for AWCF can  change significantly. With the increase in troops in Afghanistan and  eventual drawdown, it is critical that the Army monitors the unit cost ratio  in order to help ensure that inventory purchases are in line with AWCF  sales and its overall unit cost goal.
section_title: Reducing Industrial Operations’ Inventory Defers Cash Disbursements
paragraphs: At the end of fiscal year 2009, the 13 industrial operations depot  maintenance and ordnance activities had $650 million in inventory. Of that  amount, one activity—the Corpus Christi Army Depot—had $365 million  (56 percent) of the inventory. Our analysis of the Army’s accounting  reports showed that Corpus Christi had about 9.5 months of inventory on  hand at the end of fiscal year 2009. By comparison, the reported inventory  for the remaining 12 industrial operations activities represented about        2 months of inventory on hand for the same period. Maintaining high levels  of inventory at Corpus Christi or any industrial operations activity affects  the AWCF cash balances, since AWCF uses cash to purchase the  inventory. The cash is not returned to AWCF until the industrial  operations activities use the inventory in their operations (such as  repairing a tank), and then bill the customers for the work performed. This  point is discussed in AWCF guidance for the FY 2010/2011 Budget  Estimate Submission. Accordingly, the guidance states, “inventory  continues to get high level attention not only because it impacts the cash  corpus, but because the industrial operations installations should not be in  the inventory business.”
The AWCF fiscal year 2011 budget provides for industrial operations  activities’ inventories to be reduced from $650 million in 2009 to             $406 million in fiscal year 2011—a reduction of $244 million (38 percent).  This reduction will generate cash as the industrial operations activities use  up existing inventories in performing their work. The high level of  industrial operations inventories were identified when the Army  implemented the Logistics Modernization Program (LMP) system at the  Corpus Christi and Letterkenny Army depots in May 2009. LMP improved  visibility over inventory balances. Since LMP is scheduled to replace  existing systems at 10 industrial operations activities in October 2010,  additional inventory amounts could be identified on these activities’  financial reports once the system is implemented. The Army will need to  monitor its inventory levels at the 13 activities to ensure that inventory is  reduced to $406 million as specified in the budget.
The current DOD guidance on the amount of inventory to be maintained  by the industrial operations activities is ambiguous. The previous guidance  stated that “inventory items classified as operating materials and supplies  held for use, shall not exceed the amount expected to be used within         30 days unless justifying documentation supporting a supply in excess of  30 days is developed and maintained for review.” The revised guidance  requires that materials and supplies should not exceed the amount  expected to be used within normal business operations unless  documentation justifying an excess supply is developed and maintained  for review. However, the term normal business operations was not  defined. In discussing the regulations on inventory limits, Army officials  stated that the current policy of using “normal business operations” was  ambiguous. We agree with Army officials and believe that the regulation  needs to be clarified.
section_title: Collecting Funds from DLA for Consumable Inventory Items Transferred to DLA Reimburses AWCF for Funds Already Disbursed
paragraphs: Base Realignment and Closure 2005 initiatives directed the Army to  transfer the management of consumable items to DLA. The Army is  transferring management responsibility for about 26,000 different types of  consumable items (known as national stock numbers), and it plans to  complete the transfers by August 2010. The Army estimates that DLA will  reimburse AWCF $383 million and $176 million in fiscal years 2010 and  2011, respectively, for the items transferred to DLA. These amounts are  included in the AWCF fiscal years 2010 and 2011 projected cash balances.
When items are transferred from one activity to another, the gaining  activity generally receives a cash benefit and the losing activity incurs a  cash loss. Specifically, the AWCF Supply Management Activity Group  continues to pay for items on order at the time of the transfer even though  the items are delivered to and sold by DLA. Thus, the AWCF cash balance  decreases when the Army pays the suppliers for items delivered to DLA  and DLA’s working capital fund cash balance increases when the items are  sold by DLA to its customers. To ensure cash neutrality, DLA is expected  to reimburse AWCF for the funds spent by AWCF for the inventory items  on order and purchased by AWCF at the time of the transfer. Army  headquarters officials informed us that the Army and DLA have formed a  team to determine (1) the quantities of each type of item to be transferred  from AWCF to DLA, and (2) the amount of the reimbursement. The team is  expected to complete its work by August 2010.
Since the AWCF’s projected monthly cash balances for fiscal years 2010  and 2011 are based on the reimbursement of the transferred items, it is  important that the Under Secretary of Defense (Comptroller) monitor this  effort, because the AWCF expects to receive the $383 million in September  2010, but the Army and DLA do not expect to complete their work on the  amount of reimbursement until August 2010. In the past, delays in  transfers have occurred when the military services and DLA were unable  to agree on the reimbursement amounts. Delays in transferring could  result in a lower cash balance by hundreds of millions of dollars in fiscal  year 2010 than the projected amount in the AWCF cash plan.
section_title: Retaining Accumulated Operating Results Increases AWCF Cash Balance
paragraphs: The DOD Financial Management Regulation, Volume 3, Chapter 19, dated  October 2008, states that the goal of working capital funds is to achieve  zero accumulated operating results over time. The stabilized prices that  customers are charged by working capital funds for goods and services are  set to achieve this result. Thus, the stabilized prices are adjusted annually  to either return gains or recoup losses. However, the Army did not return  $491 million in accumulated operating gains to its customers in fiscal years  2010 and 2011. According to the AWCF’s fiscal year 2011 budget and Army  headquarters officials, the Army decided to retain the $491 million for  three reasons. First, if the Army returned the entire positive accumulated  operating results balance in one year, customer prices would decrease  significantly in that year and increase significantly in the following year.  Second, the Army reviewed the AWCF cash balance and projected cash  balance and determined that AWCF did not have sufficient cash to return  the entire accumulated gains to their customers. Third, AWCF retained  $491 million to partially offset prior-year cash transfers, as discussed  earlier in this report. The Army noted that it will evaluate its revised  accumulated operating results projections, cash position, and impact on  fiscal year 2012 rates in determining the amount of accumulated operating  results to retain in the next budget cycle.
section_title: Conclusions
paragraphs: While the trend of the AWCF cash balance has varied greatly over the last  10 years, the Army’s ability to maintain the AWCF’s cash balance above  the minimum cash requirement will largely depend on the actions the  Army takes now and in the future in relation to increases and decreases in  military build-up activities. While the Army does not expect a cash  shortfall in fiscal years 2010 and 2011 due primarily to an increase in  military build-up activities (sending more troops to Afghanistan), a cash  shortfall may occur if (1) the Supply Management Activity Group’s sales  are significantly lower than the wartime assumptions, or (2) the Army’s  management actions to improve the AWCF cash position are not  implemented and monitored effectively. Most notably, the Army reduced  its unit cost ratio at the AWCF supply management activities to less than  100 percent replacement. This action is expected to reduce inventory and  increase cash for AWCF in fiscal year 2010 and future years. In addition,  the Army is (1) collecting funds from DLA for consumable item transfers,  (2) retaining positive accumulated gains by not reducing its prices to  customers, and (3) reducing inventory by 38 percent at industrial  operations activities that should increase AWCF cash. Further, the  relevant DOD Financial Management Regulation lacks sufficient clarity to  determine the appropriate level of inventory to be held at industrial  operations activities. Continued monitoring of these actions and the  related impact on cash balances is needed as AWCF supports the  additional 30,000 troops in Afghanistan and the eventual drawdown.
section_title: Recommendations for Executive Action
paragraphs: We are making four recommendations to the Secretary of Defense to       (1) improve the management of the AWCF’s cash balances, and (2) clarify  the DOD Financial Management Regulation that contains guidance on  inventory levels to be maintained by the industrial operations activities.
We recommend that the Secretary of Defense direct the Secretary of the  Army to take the following actions:    Evaluate periodically the unit cost ratio (obligations to sales) and take  action to adjust the ratio as necessary, to support the war effort in Iraq  and Afghanistan and the eventual drawdown of troops.
Take action if the industrial operations activities do not reduce their  inventory levels to the specified amount in the fiscal year 2011 budget.
We recommend that the Secretary of Defense direct the Under Secretary  of Defense (Comptroller) to take the following actions:    Clarify the term normal business operations in the DOD Financial  Management Regulation as it pertains to the amount of inventory items  to be held for use by the industrial operations activities.
Oversee Army and DLA efforts to reach agreement on the amount that  DLA will reimburse AWCF for the consumable items transferred to  DLA and ensure that DLA reimburses AWCF for the items transferred  in a timely manner.
section_title: Agency Comments and Our Evaluation
paragraphs: DOD provided written comments on a draft of this report. In its comments,  DOD concurred with the four recommendations and cited actions taken,  under way, or planned to address them. For example, DOD stated that the  Under Secretary of Defense (Comptroller) will coordinate with the Under  Secretary of Defense (Acquisition, Technology and Logistics) to clarify the  term normal business operations and that the Under Secretary of Defense  (Comptroller) will update the Financial Management Regulation. DOD  stated that this is a cause for concern and will act to implement this  recommendation in the fiscal year 2012 President’s budget. DOD also  stated that it has actions under way in the areas of evaluating unit costs  and inventory levels, and monitoring the funding associated with the  consumable items transferred.
We are sending copies of this report to the Senate Committee on Armed  Services; the Subcommittee on Defense, Senate Committee on  Appropriations; the House Committee on Armed Services; the  Subcommittee on Readiness, House Committee on Armed Services; the  House Committee on Appropriations; and the Subcommittee on Defense,  House Committee on Appropriations. We are also sending copies to the  Secretary of Defense and the Secretary of the Army. The report also is  available at no charge on the GAO Web site at http://www.gao.gov.
Should you or your staff have any questions concerning this report, please  contact Asif A. Khan at (202) 512-9095 or khana@gao.gov. Contact points  for our Offices of Congressional Relations and Public Affairs may be found  on the last page of this report. Key contributors to this report are listed in  appendix III.
section_title: Appendix I: Scope and Methodology
paragraphs: To determine whether the Army Working Capital Fund (AWCF) monthly  cash balances fell within Department of Defense’s (DOD) cash  requirements for fiscal year 2000 through fiscal year 2009, we (1) obtained  the DOD regulation on calculating the minimum and maximum cash  requirements, (2) calculated the cash requirements for the period based on  the regulation, and (3) obtained monthly cash balances for the period. We  compared the minimum and maximum cash requirements to the month- ending reported cash balances. If the cash balances either exceeded the  maximum amount or were under the minimum amount, we reviewed  AWCF financial statements, budget justification books, and other reports  to ascertain the reasons for the surpluses or deficiencies, and we  discussed with Army officials the reasons for the variances. In addition,  we performed a walk-through of the Defense Finance and Accounting  Service’s processes for reconciling the Department of the Treasury trial  balance monthly cash amounts for AWCF to the balances reported on the  AWCF cash management reports. To test the reconciliations, we  reconciled the year-end cash balances between the Treasury trial balance  and the Army cash management reports for fiscal years 2000 through 2009.
To determine whether the cash transfers for fiscal years 2000 through 2009  resulted in the AWCF’s monthly cash balances falling below the minimum  cash requirement, we (1) analyzed DOD budget and accounting reports to  determine the dollar amount of transfers made for the period, and            (2) obtained journal vouchers from the Defense Finance and Accounting  Service that documented the dollar amount of the cash transfers. We  analyzed cash transfers to determine if any of the transfers resulted in  cash balances falling below the minimum cash requirement, and if so, the  amount below the minimum. We also obtained and analyzed  reprogramming documents and journal vouchers and interviewed key  Army officials to determine the reasons for the transfers.
To determine whether the AWCF projected monthly cash balances are  expected to fall below the minimum cash requirement for fiscal years 2010  and 2011 and actions the Army can take to manage those balances, we  obtained and analyzed AWCF budget documents and cash plans for the      2 years. We used the DOD regulation to calculate the minimum cash  requirement for those years and compared it to the projected cash  balances. We also compared the minimum cash requirement according to  DOD regulation to the minimum cash requirement in the fiscal year 2011  AWCF budget document. We discussed with Army headquarters officials  any differences. In addition, we met with Army headquarters officials to  discuss the impact that increased troop levels to Afghanistan will have on  the AWCF projected cash balance. We also met with officials from Army  headquarters, the Supply Management Activity Group, and the industrial  operations activity group to discuss issues that can affect AWCF cash balances. We also interviewed Army headquarters officials to  determine what actions the Army is taking or can take to increase  collections or decrease disbursements to avoid potential AWCF cash  shortages. In addition, we interviewed DOD officials and reviewed the  DOD Financial Management Regulation to determine the criteria for  maintaining inventory levels for industrial operation activities.
We performed our work at the headquarters of the Office of the Under  Secretary of Defense (Comptroller) and Office of the Secretary of the  Army, Washington, D.C.; Army Materiel Command, Fort Belvoir, Virginia;  Aviation and Missile Command, Redstone Arsenal, Alabama; TACOM  (formerly known as Tank-automotive Armament Command), Warren,  Michigan; Communications-Electronics Command, Fort Monmouth, New  Jersey; and Defense Finance and Accounting Service, Indianapolis,  Indiana.
Most of the financial information in this report was obtained from official  Army budget documents and accounting reports. To assess the reliability  of the data, we (1) obtained and analyzed reports containing detailed data  on transactions affecting the AWCF cash balance including collections, disbursements, direct appropriations to the AWCF, and funds transferredin or out of the AWCF, (2) obtained an understanding of the process used by the Defense Finance and Accounting Service to reconcile Army cas balances with Treasury records, (3) reconciled year-end cash balances  between Army reports and Treasury records, and (4) obtained and  analyzed documentation supporting the amount of funds tran the AWCF. On the basis of procedures performed, we have concluded t is report. We  these data were sufficiently reliable for the purposes of th conducted this performance audit from June 2009 through June 2010 in  accordance with generally accepted government auditing standards. Th standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence  obtained provides a reasonable basis for our findings and conclusions based on our audit objectives.
section_title: Appendix II: Comments from the Department of Defense
section_title: Appendix III: GAO Contact and Acknowledgments
subsections: section_title: GAO Contact
section_title: Acknowledgments
paragraphs: In addition to the contact named above, Greg Pugnetti, Assistant Director;  In addition to the contact named above, Greg Pugnetti, Assistant Director;  Richard Cambosos; Steve Donahue; Keith McDaniel; and Hal Santarelli  Richard Cambosos; Steve Donahue; Keith McDaniel; and Hal Santarelli  made key contributions to this report.  made key contributions to this report.