oversight

Financial Management: Analysis of Operating Cash Balance of Navy Stock Fund

Published by the Government Accountability Office on 1990-05-02.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                 United   States   General   Accounting      Office
                 Report to the Chairman,
GAO              Subcommittee on Defense, Committee
                 on Appropriations, House of
                 Representatives

May 1990
                  FINANCIAL
                  MANAGEMENT
                 Analysis of Operating
                 Cash Balance of Navy
                 Stock Fund




           RESTRICTED --Not       to be released outside     the
           General Accounting   Office unless specifically
           approved by the Office of Congqessional
           Relations.                        i
                   united   states
                   General Accounting  OfTice
                   Washington, D.C. 20648

                   Accounting and Financial
                   Management Division

                   B-239044

                   May 2,199O

                   The Honorable John P. Murtha
                   Chairman, Subcommittee on Defense
                   Committee on Appropriations
                   House of Representatives

                   Dear Mr. Chairman:

                   In an April 11, 1989, letter, you requested that we review and prepare
                   separate reports on certain Army, Navy, and Defense Logistics Agency
                   stock fund pricing and refund practices. You made this request follow-
                   ing our April 1989 report’ to you on the Air Force stock fund, which
                   discusses the budgetary impact of reducing the operating cash balance
                   of that stock fund. In responding to your most recent request, we
                   reviewed the operating cash balances of the Army, the Navy, and the
                   Defense Logistics Agency and briefed your staff on the status of our
                   work. This, the second in our series of reports on stock fund cash bal-
                   ances, presents baseline information on (1) whether the Navy stock fund
                   can operate with less than an 11-day operating cash balance, (2) how
                   refunds made to stock fund customers affected the 11-day cash balance,
                   and (3) how stock fund customers used the refunds.


                   We found that the Navy stock fund has functioned with substantially
Results in Brief   more than an 11-day operating cash balance. From 1985 through 1989,
                   the stock fund average month-end operating balance has been the
                   equivalent of about a 39-day supply of cash, or about $600 million more
                   than required if it had maintained 11 days of cash.

                   While the Navy stock fund has substantially exceeded the 1 l-day oper-
                   ating cash target, we believe, similar to our earlier position regarding
                   the Air Force, that the Navy stock fund can operate with less than an
                   1l-day operating cash balance. The Department of Defense, considering
                   the normal fluctuations in income received from customers and pay-
                   ments made to suppliers, established the 1 l-day requirement to ensure
                   that a sufficient amount of cash was available to pay bills from suppli-
                   ers. However, our analysis of the Navy’s operating cash balances from
                   fiscal year 1985 through fiscal year 1989 showed that the average



                   ‘FImncial Management: operating Cash Requirement   for Air Force Stock Fund Can Be Reduced
                   (GAO/AFMD%9BO,      April 7.1989).




                   Page 1                                                      GAO/.iFMMM9        Navy Stock Fund
                        E239044




                        While the stock fund obtains most of its funds by selling inventory items
                        to its customers, it also receives appropriations from the Congress. The
                        congressional committees indicated that these funds are intended to
                        purchase war reserve material and inventory items to support weapon
                        system modernization and modification. By designating funds for these
                        items, the congressional committees attempted to gain a degree of
                        budget visibility for certain stock fund purchases. These appropriations
                        increase the corpus of the stock fund and are available to cover stock
                        fund cash needs. For fiscal year 1990, the Navy stock fund received
                        $40.5 million in appropriated funds.

                        The stock fund has only a single cash balance consisting of both the
                        operating and appropriated cash amounts. Therefore, when calculating
                        the fund balance that is available to cover stock fund cash needs,
                        Defense officials can use the appropriated funds, to the extent they
                        remain available, to cover temporary cash shortages in the operating
                        portion of the stock fund.


                        Based on our April 1989 report on the Air Force stock fund, which dis-
Objectives, Scope,and   cusses the budgetary impact of reducing the operating cash balance of
Methodology             the stock fund, you requested that we review certain Army, Navy, and
                        Defense Logistics Agency stock fund pricing and refund practices. In
                        responding to your request, we reviewed the operating cash balances of
                        these stock funds and briefed your staff on the status of our work. The
                        objectives of our review were to determine (1) whether the Navy stock
                        fund can operate with less than an 1l-day operating cash balance,
                        (2) how refunds made to stock fund customers affected the 1 l-day cash
                        balance, and (3) how stock fund customers used the refunds.

                        To accomplish these objectives, we discussed with the Office of the Sec-
                        retary of Defense and Navy officials how stock fund (1) inventory
                        prices and surcharges are determined, (2) operating cash balances are
                        calculated, and (3) cash was returned to customers. We examined Navy
                        stock fund budget documents and related accounting records. We
                        reviewed congressional reports and legislation as well as Department of
                        Defense and Navy regulations concerning stock fund cash balances and
                        refund policies. We also reviewed the Navy’s Federal Managers’ Finan-
                        cial Integrity Act reports.

                        We performed our work at the Office of the Secretary of Defense, Office
                        of the Comptroller of the Navy, the Naval Supply Systems Command,
                        and the Navy Accounting and Finance Center. We conducted our work


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                                         B-239044




Table 1: Information on the Stock Fund
Operating Cash Balances for Fiscal       Dollars in millions
Years 1995 Through 1999                                                    Fiscal          Average        Range Of month-end
                                                                        year-end         month-end             balances
                                         Fiscal year                     balance           balance          High          Low
                                         1985                              $1,084               $938      $1,084          $760
                                         1986                                 742                996       1,358           699
                                         1987                                 693                957       1,495           439
                                         1988                                 574                725       1,077           262
                                         1989                                 635                572         702           474


                                         Table 1 shows that for the B-year period, the fiscal year-end and aver-
                                         age month-end cash balances were always greater than $500 million and
                                         that the lowest balance was $262 million in 1988. To relate this informa-
                                         tion to an 1 l-day requirement, table 2 provides the same data as shown
                                         in table 1, but converts the dollar information to equivalent days. To
                                         determine the equivalent days of cash for each fiscal year, we used the
                                         Department of Defense formula of total stock fund operating expendi-
                                         tures divided by 360 days. The one day disbursement rate for fiscal
                                         years 1985 through 1989 was $19.4 million, $21.3 million, $21.8 million,
                                         $22.6 million, and $23.3 million, respectively.

Table 2: Information on the Stock Fund
Operating Cash Balances for Fiscal                                            Fiscal       Average        Range Of month-end
Years 1985 Through 1999 Converted to                                       year-end      month-end             balances
Equivalent Days                          Fiscal year                        balance        balance          High          Low
                                         1985                                       56               48       56             39
                                         1986                                       35               47       64             33
                                         1987                                       32               44       69             20
                                         1988                                       25               32       48             12
                                         1989                                       27               25       30             20


                                         Table 2 shows that the fiscal yearend and average month-end Navy
                                         stock fund operating cash balances have been substantially higher than
                                         11 days. Except for a brief period in 1988, the stock fund operating cash
                                         balance did not go below 20 days. The reason the operating cash balance
                                         fell to 12 days at one point in 1988 was because the Navy refunded
                                         $828 million to customers, or an equivalent of a 37-day supply of cash,
                                         during May and June of that year. The impact of refunds is discussed
                                         later in this report.




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                                         B-239044




                                         Our analysis also showed that for the 5-year period, the operating cash
                                         balance varied by more than a 5-day supply of cash in 21 months. The
                                         cash balance rose by more than 5 days 18 times and fell by more than 5
                                         days 3 times. According to Navy officials, on the three occasions that
                                         the cash balance decreased, the Navy did not properly process collection
                                         or expenditure data that resulted in the operating cash balance for the
                                         month being lower than it should have been.

                                         For example, between August and September 1986, the operating cash
                                         balance decreased by $191 million or the equivalent of a g-day supply of
                                         cash. According to Navy officials, the cash balance decreased because
                                         the Navy did not promptly process $135 million or 6 days of collections
                                         during September. If this collection data had been processed during Sep-
                                         tember when it should have, the operating cash balance would have
                                         decreased by about $56 million, or 3 days.


                                         The Navy has made substantial amounts of refunds from the stock fund
Refunds Total Over                       to its customers-over   $3.4 billion since fiscal year 1985. These refunds
$3.4 Billion in Last 5                   have helped the Navy reduce the excessive amounts of operating cash in
Years                                    the stock fund. Table 3 shows the refunds made during the year as well
                                         as the fiscal yearend operating cash balances after refunds, in dollars
                                         and equivalent days.

Table 3: Stock Fund Refunds and Year-
end Operating Cash Balances for Fiscal   Dollars in mihons
Years 1985 Through 1989                                                             Refunds              Operating cash after refunds
                                                                     -
                                                                                              Equivalent                    Equivalent
                                         Fiscal year                       Amount                   days     Amount               days
                                         1985                                    $194                 10        _ ,.~.
                                                                                                               $1  084               __
                                                                                                                                     56
                                         1986                                     .890   ___          42              742                35
                                         1987                                    1,383                63              693                32
                                         1988                                      916                41              574                25
                                         1989                                       25                 1              635                27
                                         Total                                 $3.407’

                                         aTotal does not add due to rounding

                                         Of the $3.4 billion amount, the Navy made $2.1 billion in refunds with
                                         various levels of congressional involvement and approval. These
                                         refunds were generally intended to offset budget reductions in the cus-
                                         tomers’ accounts, which allowed Navy units to have more money to
                                         spend for general operating and maintenance purposes. When we
                                         attempted to determine how these refunds were used by customers, we


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                                         B-239044




Table 4: Amount of Refunds Received by
Stock Fund Customers From Fiscal         Dollars in millions
Years 1985 Through 1989                  Customer                                             1985      1988      1987      1988     1989
                                         Navy, Operation and Maintenancea                      $194     $830    $1 ,011     $879        $0
                                         Navy Reserve, Operation and Mafntenance                  0        59        67        0         0
                                         Army, Operation and Maintenance                          0         0        67        0         0
                                         Air Force, Operation and Mafntenance          -          0         0        45        0         0
                                         Marine Corps, Operation and Mamtenance                   0         1         0       15         0
                                         Navy Industrial Fund                                     0         0         8         0         0
                                         Navy Aircraft Procurement                                0         0       186         0         0
                                         Coast Guard                                              0         0         0       22        25
                                         TotaP                                                $194      $SSa $1,383         $918       $25
                                         aThe amounts received by Navy Operatfon and Maintenance customers to purchase avration depot-level
                                         repafrables follow: $558 millfon rn 1986,$487 millfon in 1987, and $6fj mrllion rn 1999
                                         bTotals may not add due to roundrng

                                         Over the last 5 years, $2.9 billion, or 86 percent, of Navy stock fund
                                         refunds have been received by the Navy, Operation and Maintenance
                                         appropriation. The Navy, Operation and Maintenance appropriation
                                         amounts include funds received by customers to purchase aviation
                                         depot-level repairable inventories.


                                         Since 1985, the Navy stock fund operating cash balance has been sub-
Conclusion                               stantially more than an 1 l-day cash requirement and can be reduced.
                                         During 1989, the House and Senate Appropriations Committees recom-
                                         mended that Defense change its policy and lower the stock fund operat-
                                         ing cash requirement from 11 days to 5 days. Our analysis shows that a
                                         5-day cash supply is adequate and, as a result, we are not making any
                                         recommendations at this time.

                                         As requested by your office, we did not obtain written comments on a
                                         draft of this report. We did, however, discuss its contents with pertinent
                                         Defense and Navy officials and have incorporated their views where
                                         appropriate.

                                         Unless you publicly announce the contents of this report earlier, we will
                                         not distribute it until 30 days from its date. At that time we will send
                                         copies to the Secretary of Defense, the Secretary of the Navy, and other
                                         interested parties. We will also make copies available to others upon
                                         request.




                                         Page 9                                                       GAO/AFbKMt@6S       Navy Stack Fond
Page 11   GAO/AFMB99-69   Navy Stack Fund
Appendix I

Major Contributors to This Report


                       Joseph Potter, Assistant Director, (202) 695-6922
Accounting and         Gregory Pugnetti, Accountant-in-Charge
Financial Management   Heidikitt Winter, Accountant
Division, Washi$ton,
DC.




(903111)               Page 12                                       GAO/APMLHKG9   Navy Stock Fund
E-299044




Please contact me at 275-9607 if you or your staff have any questions
concerning this report. Other major contributors to this report are listed
in appendix I.

Sincere1y yours,




Jeffrey C. Steinhoff
Director, Financial Management
   Systems and Audit Oversight




 page 10                                       GAO/AlTdD90-69   Navy Stack Fund
E&239044




found that the refunds had been merged with customers’ appropriations
and, therefore, had lost their identity. Navy officials told us that there is
no requirement to (1) separately account for these refunds and
(2) determine how these refunds are used. As a result, neither we nor
the Navy could determine how the refunds totaling $2.1 billion were
ultimately used other than for the general purposes of the appropriation
which received the refund.

Navy officials told us that the remaining $1.3 billion in refunds was
used by customers to purchase aircraft inventory, which is commonly
referred to as aviation depot-level repairables. In 1985, the Navy began
financing the aviation depot-level repairable inventories through the
stock fund. At that time, the Navy stock fund received aviation invento-
ries valued at about $12 billion without paying for them because the
Navy had already purchased these items with appropriated funds2 Fur-
ther, customers now had to use their operation and maintenance funds
to pay for aviation inventories that, prior to 1985, had been paid for
with other appropriations. To ensure that customers had sufficient
operation and maintenance funds to fulfill their missions, the Navy
decided to refund $1.3 billion to them from 1986 through 1988.

The $3.4 billion in refunds were made to the following customers. While
we were not able to determine how all the refunds were used, table 4
shows the amount of refunds made from the Navy stock fund from fis-
cal years 1985 through 1989.




‘We are currently performing, at your request, a comprehensive review of Navy appropriations,
facial    managmenent, internal controls, and budget execution changes from when its stock fond
began to finance depot-level repairables. As stated above, the Navy stock fund received $12 billion in
inventory without paying for it. You also requested that we review similar factors in the Army and
Air Force, should these services begin financing depot-level repairables through their stock funds. We
will be reportii on these issues at a later date.



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                               B-239044




                               According to Defense budget documents, the Navy planned to reduce its
                               operating cash balance to 11 days at the end of fiscal year 1989. How-
                               ever, as tables 1 and 2 show, the Navy did not do this, ending fiscal year
                               1989 with a 27-day supply of cash or $379 million more than planned.
                               When we questioned Navy officials about why the year-end cash bal-
                               ance was so high, they told us that the budget is an estimate and that
                               the Navy had overestimated the amount of expenditures to be incurred
                               in fiscal year 1989. As a result, the fiscal year-end 1989 operating cash
                               balance was larger than planned.

                               In our April 1989 report, we stated that the Air Force stock fund operat-
                               ing cash balance could be substantially reduced. By reducing the cash
                               target below 11 days, the surcharge added to the selling price of inven-
                               tory items should be reduced, thus lowering the prices the stock fund
                               charges its customers by a corresponding amount. This, in turn, could
                               result in a reduction to Defense budget authority.

                               Acting on our recommendations, in November 1989 the House and Sen-
                               ate Appropriations Committees recommended lowering the stock fund
                               operating cash requirement from 11 days to 5 days, which resulted in
                               the Congress reducing the fiscal year 1990 Defense budget by
                               $707.2 million. Further, because stock fund customers should theoreti-
                               cally be able to purchase the same quantity of items at reduced prices,
                               the customers’ ability to perform their missions should not be adversely
                               affected.


Decreasesin Stock Fund         The viability of the recently adopted 5-day operating cash target was
Month-end Cash Balances        borne out in the Navy stock fund. Our analysis of the operating cash
                               balances from fiscal years 1985 through 1989 showed that the average
Usually   Less Than   5 Days   month-end change was 4.4 days.

                               Since the cash balance is designed to cover normal fluctuations in stock
                               fund income and payments, changes in the month-end cash balances are
                               a key measure in analyzing the needed level of the stock fund cash bal-
                               ance. In analyzing the month-end changes in the operating cash bal-
                               ances, we adjusted the operating cash balances for refunds. As agreed
                               with the Office of the Secretary of Defense and Navy officials, refunds
                               need to be added back to the operating cash balance because they are
                               not part of the normal stock fund process of income received from cus-
                               tomers and payments made to vendors.




                               Page 6                                         GAO/AFMD-90.59 Navy Stock Fund
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                         B-239044




                         from June 1989 through March 1990 in accordance with generally
                         accepted government auditing standards.

                         For our review, Navy officials provided us with month-end data on the
                         appropriated and operating cash balances, which were developed from a
                         statistical estimate of the total cash balance. We did not verify the accu-
                         racy of the statistical estimate. In performing our work, we analyzed the
                         month-end Navy stock fund cash balances. When large fluctuations in
                         the cash balances occurred from one month to the next month, we
                         obtained Navy officials’ explanations for the fluctuations.

                         The Subcommittee also asked us to provide it certain information
                         regarding the use of refunds. In this report, the term “refund” describes
                         two kinds of payments: (1) payments made under various statutory
                         transfer authorities and (2) payments made to adjust the original price
                         charged stock fund users. Although different legal consequences may
                         attach to the funds paid, depending on the basis used for payment, we
                         have used the same term to cover both.


                         The Navy stock fund has functioned with substantially more than an 1 l-
Stock Fund Operated      day operating cash balance. Navy information shows that the Navy low-
at Substantially More    ered its average month-end stock fund operating cash balance from 48
Than an 11-Day           days to 26 days between fiscal years 1985 and 1989. However, a 25-day
                         operating cash balance is still substantially greater than needed, and
Operating Cash           even an 1 l-day balance is excessive. Our analysis of the operating cash
Balance                  balances from fiscal years 1985 through 1989 showed that the average
                         month-end change was only 4.4 days. In essence, the cash balances
                         changed, on average, less than 5 days from one month to the next,
                         which was less than the 5-day cash target recommended by the House
                         and Senate Appropriations Committees.


5-Year Analysis of the   Table 1 displays the fiscal year-end balances, the average month-end
Stock Fund Operating     balances, and the range of the cash balances from 1985 through 1989.
Cash Balance




                         Page 4                                         GAO/AlTdlMMS   Navy Stock Fund
             5239044




             change in the cash balances from one month to the next month was only
             4.4 days.

             While the Navy stock fund has maintained a large operating cash bal-
             ance for the past 5 years, the stock fund has also refunded $3.4 billion
             to selected customers. These refunds have helped the Navy reduce the
             excessive amounts of operating cash in the stock fund. We were unable,
             just as the Navy was unable, to determine the ultimate disposition of
              $2.1 billion in refunds because they were merged into other accounts.
              For the remaining $1.3 billion, Navy officials told us these funds were
              used to purchase inventories for the repair of aircraft.


             The Department of the Navy stock fund is to provide for the financial
Background   management, inventory control, and distribution of consumable supply
             items to support both the Navy and Marine Corps peacetime and war-
             time operations. In addition, the Navy stock fund sells inventory items
             to other agencies, such as the Army, Air Force, and Coast Guard. While
             stock fund items are normally consumable items, the Navy stock fund
             also includes more expensive items that can be repaired. These expen-
             sive items are known as depot-level repairables. At the end of fiscal year
              1989, the stock fund had a total reported inventory value of $31.3 bil-
             lion and annual sales of $8.8 billion. The total assets held by the stock
             fund, consisting of inventory and cash, are referred to as the stock fund
             corpus.

             The stock fund operates under a revolving fund concept, whereby it
             buys and holds inventory for sale to authorized customers, such as
             activities funded by the Navy’s Operation and Maintenance appropria-
             tion. Sales of stock fund inventory generate cash that is used to replen-
             ish inventory levels.

             To ensure that sufficient cash is available to pay incoming bills from
             suppliers, Department of Defense Regulation 7420.13-R requires that
             the stock fund maintain a certain level of funds with Treasury. Until
             November 1989 when the House and Senate Appropriations Committees
             recommended reducing this balance to 5 days, Defense had used 11 days
             of operating cash to accommodate fluctuations in revenue received from
             customers and payments made to vendors. Such a cash level is achieved
             by adding a surcharge to the acquisition cost of inventory items when
             setting prices charged customers. For the Navy stock fund, disburse-
             ments for 1 day are currently worth about $23.3 million, for an 11-day
             total of $256.3 million.


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