DOD Payments to Small Business: Implementation and Effective	 
Utilization of Electronic Invoicing Could Further Reduce Late	 
Payments (19-MAY-06, GAO-06-358).				 
                                                                 
The National Defense Authorization Act for Fiscal Year 2004	 
requires GAO to report on the timeliness of Department of Defense
(DOD) payments made to small businesses. GAO's report focuses on 
(1) whether, at DOD payment centers for which data were 	 
available, small business invoices were more likely to be paid	 
late; (2) whether systemic weaknesses in DOD payment processes	 
result in late payments to contractors--including small business 
contractors; and (3) the impact of late payments on small	 
businesses. To calculate timeliness rates, GAO used the data DOD 
was able to provide for 9 of its 20 vendor payment locations as  
well as its one contract pay location. GAO used a case study	 
approach for the third objective because data limitations did not
permit the use of statistically reliable sampling techniques for 
assessing the experiences of DOD small business contractors as a 
whole. Case study contractors were selected because they	 
experienced a high frequency of late payments and may not be	 
reflective of all small businesses.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-358 					        
    ACCNO:   A54359						        
  TITLE:     DOD Payments to Small Business: Implementation and       
Effective Utilization of Electronic Invoicing Could Further	 
Reduce Late Payments						 
     DATE:   05/19/2006 
  SUBJECT:   Cash management					 
	     Contractor payments				 
	     Department of Defense contractors			 
	     Financial analysis 				 
	     Financial management				 
	     Internal controls					 
	     Late payments					 
	     Small business contractors 			 
	     Timeliness 					 

******************************************************************
** This file contains an ASCII representation of the text of a  **
** GAO Product.                                                 **
**                                                              **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced.  Tables are included, but    **
** may not resemble those in the printed version.               **
**                                                              **
** Please see the PDF (Portable Document Format) file, when     **
** available, for a complete electronic file of the printed     **
** document's contents.                                         **
**                                                              **
******************************************************************
GAO-06-358

     

     * Results in Brief
     * Background
          * Prompt Payment Act Requirements
          * DOD's Commercial Payment Process
     * Small Business Invoices Paid Late More Often Than All Invoices Paid at
       Vendor Pay Locations
     * Long-standing Weaknesses in DOD's Vendor Payment Processes Result in
       Late Payments to Contractors, Including Small Business Contractors
          * DOD's Cash Management Practices May Disadvantage Small Businesses
          * Electronic Commerce Tools Could Improve the Timeliness of
            Payments Made through DOD's Vendor Payment Process
     * Late Payments May Create Financial Hardship for Some Small Business
       Contractors
     * Conclusion
     * Recommendations for Executive Action
     * Agency Comments and Our Evaluation
     * Appendix I: Comments from the Department of Defense
     * Appendix II: Objectives, Scope, and Methodology
          * Order by Mail or Phone

Report to Congressional Committees

United States Government Accountability Office

GAO

May 2006

DOD PAYMENTS TO SMALL BUSINESSES

Implementation and Effective Utilization of Electronic Invoicing Could
Further Reduce Late Payments

GAO-06-358

Contents

Letter 1

Results in Brief 4
Background 7
Small Business Invoices Paid Late More Often Than All Invoices Paid at
Vendor Pay Locations 12
Long-standing Weaknesses in DOD's Vendor Payment Processes Result in Late
Payments to Contractors, Including Small Business Contractors 14
Late Payments May Create Financial Hardship for Some Small Business
Contractors 20
Conclusion 24
Recommendations for Executive Action 25
Agency Comments and Our Evaluation 25
Appendix I Comments from the Department of Defense 28
Appendix II Objectives, Scope, and Methodology 31

Tables

Table 1: Percentage of Invoices Paid Late by DFAS Location and Small
versus All Business for Fiscal Year 2004 13
Table 2: Case Study Examples of Small Business Invoices Paid Late by DFAS
22

Figure

Figure 1: Overdue Invoices on Hand as a Percentage of Total Invoices
Processed for DOD's Vendor Pay and Contract Pay Business Lines for Fiscal
Years 2001 through 2005 11

Abbreviations

BTA Business Transformation Agency BUMED Navy Bureau of Medicine and
Surgery CCR Central Contractor Registration database CVFR current value of
funds rate DCMA Defense Contract Management Agency DFARS Defense Federal
Acquisition Regulation Supplement DFAS Defense Finance and Accounting
Service DISA Defense Information Systems Agency DOD Department of Defense
EDI electronic data interchange NFIB National Federation of Independent
Businesses OSBP Office of Small Business Programs SBA Small Business
Administration WAWF Wide Area Work Flow

This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
its entirety without further permission from GAO. However, because this
work may contain copyrighted images or other material, permission from the
copyright holder may be necessary if you wish to reproduce this material
separately.

United States Government Accountability Office

Washington, DC 20548

May 19, 2006

Congressional Committees

Small businesses are an important player in the U.S. economy-employing
half of all private sector employees and generating 60 to 80 percent of
net new jobs annually over the past decade. As such, the federal
government's long-standing policy has been to maximize federal procurement
opportunities for small businesses. 1 To ensure that small businesses
receive a share of federal procurement contract dollars, the Congress has
mandated that the Small Business Administration (SBA) negotiate annual
procurement goals with each federal agency. In fiscal year 2004, the
Department of Defense (DOD) reported meeting its procurement goal-awarding
prime contracts totaling a reported $44.8 billion, or 23.1 percent of
total contract award dollars, to small business contractors. 2 However, as
we have reported in the past, 3 DOD's payment processes often results in
late payments to contractors-which for some small business contractors
could lead to financial hardship.

Concerned about the impact late payments have on small business
contractors, the Congress included in the National Defense Authorization
Act for Fiscal Year 2004 a requirement for us to report on the timeliness
of DOD payments to small business contractors. 4 Specifically, we were
asked to provide estimates of the total amount of contract payments made
to small businesses and the percentage of total contract payments to small
businesses that were not made in a timely manner. However, DOD was unable
to provide us with a complete population of transaction-level payment data
that would be needed to provide such estimates. Therefore, as agreed with
your offices, we (1) determined whether, at selected DOD payment
locations, small business invoices were more likely to be paid late when
compared with the payment of all invoices; (2) determined whether systemic
weaknesses in DOD payment processes result in late payments to
contractors-including small business contractors; and (3) assessed the
impact that late payments can have on small business contractors.

1 A small business concern is defined in accordance with the Small
Business Administration's definition, 13 C.F.R. pt. 121. Small businesses
may be eligible to participate in several programs-including small
disadvantaged, 8(a), HUBZone, veteran owned, service-disabled
veteran-owned, and women-owned small businesses. See 48 C.F.R. S:S:
19.000, 219.000.

2 For fiscal years 2004 and 2005 DOD's procurement goal was to award to
small businesses 23 percent of its total contract awards. As of the date
of this report, DOD's fiscal year 2005 procurement statistics were not
available.

3 GAO, Financial Management: DOD's Metrics Program Provides Focus for
Improving Performance, GAO-03-457 (Washington, D.C.: Mar. 28, 2003), and
Financial Management: Seven DOD Initiatives That Affect the Contract
Payment Process, GAO/AIMD-98-40 (Washington, D.C.: Jan. 30, 1998).

4 Pub. L. No. 108-136, S: 851, 117 Stat. 1392, 1556 (Nov. 24, 2003). For
the purpose of this report and as specified by the National Defense
Authorization Act of 2004, timeliness is defined in accordance with the
Prompt Payment Final Rule, 5 C.F.R. pt. 1315.

5 31 U.S.C. ch. 39. DOD also makes commercial payments that are not
subject to the Prompt Payment Act that include, among other things,
contract financing payments, progress payments, interim payments, and
advance payments.

6 DOD also uses Electronic Data Interchange and Web Invoicing applications
to transmit payment documents and data electronically. However, because
WAWF provides greater visibility over the status of payments and payment
documents, it is DOD's stated goal that all electronic invoicing be
performed using WAWF.

7 Pub. L. No. 106-398, S: 1008, 114 Stat. 1654, 1654A-249 (Oct. 30, 2000).

8 Invoices related to certain types of contracts, such as construction
contracts, must be certified by a DOD contracting official, who then
forwards the certified invoice to the appropriate DOD vendor pay site for
payment.

9 15. U.S.C. S: 632 (a) (1).

10 Id. at S: 632 (a) (3).

11 31 U.S.C. S: 3902.

12 Id. at S: 3904.

13 5 C.F.R. S: 1315.5 (b).

14 5 C.F.R. S: 1315.4 (g). The start of the payment period is the later of
(1) the receipt of the proper invoice by the designated billing office or
(2) the government's acceptance of supplies delivered or services
performed by the contractor.

15 31 U.S.C. S: 3902 (b).

16 70 Fed. Reg. 76497, December 27, 2005. (See
www.publicdebt.treas.gov/opd/opdrmt2.htm.)

17 The fast pay procedure allows payment under limited conditions to a
contractor prior to the government's verification that supplies have been
received and accepted. (48 C.F.R. subpt. 13.4). Among other conditions,
deliveries of supplies are to occur at locations where there is both a
geographical separation and a lack of adequate communications facilities
between government receiving and disbursing activities that will make it
impractical to make timely payment based on evidence of government
acceptance.

18 GAO-03-457 .

19 GAO/AIMD-98-40 .

20 Defense Federal Acquisition Regulation Supplement, 48 C.F.R. S:
232.903. Small disadvantaged businesses are a subset of the larger
population of small business contractors. The payment data provided by DOD
did not allow us to isolate and analyze payments made to small
disadvantaged businesses.

21 Agencies may pay early if the discount terms result in an annual
interest rate equal to, or higher than, the Current Value of Funds Rate
(CVFR). Department of the Treasury, Treasury Financial Manual, vol. I, pt.
6, S: 8040.40. The CVFR is published quarterly by the Secretary of the
Treasury.

22 Pub. L. No. 106-398, S: 1008, 114 Stat. 1654, 1654A-249 (Oct. 30,
2000).

23 Subsection 1008(c) authorized the Secretary to exempt any category of
invoices from this requirement if he determines that adherence to the
requirement would be "unduly burdensome." Through DOD's implementing
regulations, the Secretary has exempted invoices where vendors are unable
to submit invoices electronically, among other categories. DFARS
232.7002(a).

24 DFARS 252.232-7003.

25 Although DFARS 252.232-7003 provides several electronic submission
options, DOD has designated WAWF as the preferred electronic invoicing
tool because it provides greater visibility over the status of payments
and payment documents.

26 Invoices may contain multiple lines of accounting, or funding sources.
DFAS must match each line of accounting with the official accounting
records to ensure that funds are available.

27 Invoices related to certain types of contracts, such as construction
contracts, must be certified by a DOD contracting official, who then
forwards the certified invoice to the appropriate DOD vendor pay site for
payment.

28 DFARS 232.7002(b). While subsection 1008(c) of the National Defense
Authorization Act also authorized the Secretary to exempt categories of
transactions from the electronic transmission requirement, DOD's
implementing regulations currently allow for no such exemptions.

29 31 U.S.C. S: 3902.

30 National Federation of Independent Businesses, National Small Business
Poll: The Cash Flow Problem, vol. 1, no. 3 (2001).

31 The Prompt Payment Act provides that an invoice is deemed to be
received on the later of (1) the date a proper invoice is received by an
agency if the agency annotates the invoice with the date of receipt or (2)
the seventh day after the date on which goods are delivered or services
completed, unless acceptance occurs earlier or if a longer acceptance
period is specified in the contract. 5 C.F.R. S: 1315.4 (b) (1). If the
agency fails to annotate an invoice with the date of receipt of the
invoice, the date placed on the invoice by the contractor is used to
determine the start date for the payment period. Id. at S: 1315.4 (b) (2).
Further, agencies are required to return improper invoices to the
contractor within 7 days of receipt to identify deficiencies in the
invoice. 5 C.F.R. S: 1315.4 (c).

1 15 U.S.C. S:S: 631-657g.

2 31 U.S.C. ch. 39; 5 C.F.R. pt. 1315.

3 48 C.F.R. pt. 219 and subpt. 232.9.

4 Id. at pt. 32.

5 GAO, Standards for Internal Control in the Federal Government,
GAO/AIMD-00-21 .3.1 (Washington, D.C.: November 1999). These standards
provide the overall framework for establishing and maintaining effective
internal control and for identifying and addressing areas of greatest risk
of fraud, waste, abuse, and mismanagement.

DOD separates its payment of commercial invoices into two business
lines-(1) contract pay-which pays invoices for larger, more complex
contracts and (2) vendor pay-which processes payments for smaller, less
complex contracts, purchase orders, and other miscellaneous payments.
DOD's contract payment business line is managed and operated through a
single DOD location, whereas DOD's vendor payment business line is managed
and operated by 20 separate payment locations. For fiscal year 2004, DOD
reported total commercial payments subject to the Prompt Payment Act, as
amended, 5 of $206 billion-of which $119 billion were paid through DOD's
contract pay business line and $87 billion were paid through its vendor
pay business line. To determine whether small business invoices were more
likely to be paid late when compared with the payment of all invoices, we
requested transaction-level detail for all DOD commercial payments subject
to the Prompt Payment Act and all interest penalties paid in fiscal year
2004. We received all the payment data requested for DOD's contract
payment business line. However, DOD was able to provide us with data for
only 9 of its 20 vendor payment locations. The $24 billion of payments
generated from these 9 vendor pay locations represented approximately 28
percent of the total $87 billion of vendor payments subject to the Prompt
Payment Act. According to DOD officials, they were unable to provide us
with payment data for the remaining 11 locations because they could not
reconcile the data with previously reported prompt payment metrics-which
is critical for ensuring that the data are complete.

Using the payment data from the nine vendor pay locations and one contract
pay location, combined with data we obtained from the Central Contractor
Registration (CCR) database-which contains the most comprehensive listing
of small business contractors-we calculated the extent to which small
business invoices are paid late as compared with all invoices.
Specifically, we used the data from CCR to identify invoice and interest
payments associated with small business contractors. However, payment data
for the nine vendor pay sites did not always contain complete identifier
data that would allow us to determine whether the transactions were
associated with small businesses; some sites contained fairly complete
data and others were missing identifiers for a large percentage of
transactions. Because we were not able to identify all small businesses,
our calculations compare the percentage of invoices paid late that were
submitted by known small businesses with the percentage of all invoices
paid late. To determine the percentages of invoices paid late, we divided
the number of invoices paid late by the total number of invoices paid
during the same period. To ensure that the DOD data we used to support
this report were sufficiently reliable for our analyses, we conducted
detailed reliability assessments of the data sets that we used. We
restricted these assessments, however, to the specific variables that were
pertinent to our analyses. We found that all the data sets used in this
report were sufficiently reliable for these analyses. See appendix II for
a further discussion of these calculations and limitations.

To determine the cause of late payments, we performed audit work at 6 of
DOD's 20 vendor payment locations and DOD's 1 contract pay site, which
collectively represent $169 billion, or 82 percent of all payments subject
to the Prompt Payment Act. We selected vendor pay sites based on, among
other things, the amount of interest penalties paid at each
location-selecting sites that paid both high and low amounts of interest.
Using DOD payment and other data, we identified small business contractors
that were paid late multiple times during fiscal year 2004 and documented
the difficulties experienced by 17 of these contractors. We selected our
case study examples from the DOD payment data provided and identified
small business contractors that DOD paid late most frequently. Of those
small business contractors that were paid late most frequently, 17
expressed a willingness to share information on late payments with us. We
relied on a case study approach to achieve this objective, principally
because, as noted previously, DOD was unable to provide us with a complete
universe of small business contractors that were paid late-which would be
needed to perform statistically reliable sampling techniques that would
allow us to comment on the experiences of DOD small business contractors
as a whole. Our findings for this objective cannot be projected and may
not be representative of the experiences of all DOD small business
contractors. We requested comments on a draft of this report from the
Secretary of Defense or his designee. We received written comments from
the Deputy Under Secretary of Defense (Business Transformation), which are
reprinted in appendix I of this report. Our work was performed from
November 2004 through January 2006 in accordance with U.S. generally
accepted government auditing standards. Additional details on our scope
and methodology are included in appendix II.

Results in Brief

In general, our analysis of DOD's fiscal year 2004 payment data for nine
DOD vendor pay locations showed that to varying degrees, small business
invoices were paid late more often than all invoices paid at each of the
nine vendor payment locations. Overall, at these nine vendor pay
locations, 10 percent of all invoices were paid late-compared with 14.5
percent of small business invoices. According to DOD vendor pay officials,
the disparity between the payment of small business invoices and all
invoices may exist because DOD's cash management practices place a lower
priority on the payment of smaller, less-complex invoices-like those
typically submitted by small business contractors. Further, these vendor
payment sites lacked the demographic information needed to implement DOD's
policy which allows for the payment of small-disadvantaged businesses
early. Although many of the same prioritization practices were used by
DOD's contract pay site, they did not result in a timing disparity
because, for the most part, DOD's contract pay site pays its bills on
time-paying only 2 percent of all invoices late. However, many of the
efficiencies that are used in DOD's contract pay business line cannot be
cost effectively applied to improve the timeliness of payments at DOD's
vendor pay sites. For example, the receipt and acceptance process used by
the contract pay business line is often performed by a government
representative located at the contractor's facility. While this speeds the
payment process, it is also more costly and, therefore, cannot be
practically applied to DOD's vendor pay product line. Given that DOD's
vendor pay business line presents the most significant challenge for DOD,
with respect to paying invoices on time, we focused specifically on DOD's
vendor payment processes and actions needed to improve the timeliness of
payments made through these processes.

Systemic weaknesses in DOD's vendor payment processes result in late
payments to contractors, including small business contractors. For
decades, we have reported that the leading cause of late payments at DOD
stems from delays in receiving the payment documents needed to complete a
payment transaction-including receiving and acceptance documents. The
delayed processing of these payment documents is caused, in large part, by
the paper-driven nature of DOD's vendor payment process and DOD's
nonintegrated payment, accounting, and logistics systems. Although, DOD
has reported significant improvements in its metrics related to late
payments, these improvements have come through dedicating additional
resources to the problem and not through addressing the underlying
weaknesses that cause late payments. Recently, however, DOD invested in a
Web-based tool known as Wide Area Work Flow (WAWF), 6 which, if
implemented and utilized effectively, could reduce the problems created by
DOD's nonintegrated financial systems by facilitating the electronic
transmission of payment documents and data. According to DOD, WAWF is
intended to (1) be a major component of the department's compliance with
the electronic invoicing requirements of the Floyd D. Spence National
Defense Authorization Act for Fiscal Year 2001 7 and (2) contribute to the
department's goal of reducing interest charges for late payments to
vendors. However, DOD's WAWF program lacks the management information and
strategic direction needed to be successful. Specifically, DOD lacks the
metrics needed to know whether WAWF is being utilized and, if not, what
the barriers are to more effective utilization. In addition, the program
management of this initiative has changed hands numerous times, has not
clearly defined the roles and responsibilities of the organizations that
are integral to the program's success, and does not have a written
strategy for ensuring that WAWF will be effectively utilized. Finally,
while the electronic invoicing provisions included in the National Defense
Authorization Act for Fiscal Year 2001 require contractors to submit
invoices electronically, there is no clear legal and regulatory
requirement for the military services and defense agencies to process
receiving and acceptance reports and other payment-related documentation
electronically when contractors send their invoices directly to DOD vendor
payment sites-which is often the case. 8

Disruptions of cash flow caused by late payments-depending on the extent
and duration-can impact the day-to-day operations of small businesses. To
obtain a perspective on the effect late payments can have on small
business contractors, we interviewed and, when available, obtained payment
documentation from 17 small business contractors that were paid late
multiple times during fiscal year 2004. According to 14 of the 17
contractors we spoke with, late payments from DOD created cash flow
problems, which ultimately led them to seek and obtain a line of credit in
order to finance their day-to-day operations. Further, although DOD is
required by the Prompt Payment Act to pay interest penalty payments when
certain bills are paid late, 10 of the contractors we spoke with said they
often did not receive interest on payments they considered late. In an
effort to substantiate the contractors' assertions, we requested payment
documentation from DOD-including invoices, receiving reports, and other
relevant payment documents-for the 3 small business contractors that
provided us with information that they believed demonstrated that they
were owed interest. However, DOD was unable to provide us with the
requested documentation, and therefore, we were unable to confirm the
contractors' assertions. Nonetheless, according to one of the small
business owners, after we asked DOD to research the contractor's claims,
DOD determined that the contractor was entitled to interest penalty
payments of approximately $1,000-which, according to the contractor, DOD
later paid. Further, according to 11 of the small business contractors we
spoke with, when interest is received, it is less than the small
businesses' cost of capital. For example, using the prompt payment rate of
4.25 percent, which was in effect as of June 2005, DOD paid interest of
$199 to one small business contractor on an $84,150 invoice paid 20 days
past its due date. However, financing $84,150-using the 7.250 percent
interest rate available through the contractor's line of credit-would cost
the small business owner $340.

We are making five recommendations to improve the timeliness of DOD
payments, including payments to small business contractors. Specifically,
we are recommending that DOD (1) clarify its management structure for WAWF
and provide strategic direction for DOD and the military services in their
efforts to implement and effectively utilize WAWF; (2) establish a
strategic plan that defines the roles and responsibilities of the various
organizations that are integral to the program's success; (3) develop
performance metrics to measure the success of the program; (4) consider
incorporating, as part of the WAWF application, a data element that would
flag invoices submitted by small disadvantaged business so that they could
be paid early, in accordance with DOD policy; and (5) require the military
services and defense agencies to process all DOD receiving and acceptance
reports and other supporting payment documentation electronically.

In written comments, which are reprinted in appendix I, DOD concurred with
our recommendations and affirmed its commitment to fully implementing and
effectively utilizing WAWF. DOD noted its plans to provide clear direction
and a strategic plan for WAWF, including evaluating and revising existing
WAWF metrics and considering, as part of its next WAWF requirements
review, a data element that would flag invoices submitted by small
disadvantaged businesses. DOD also stated that, as part of its strategic
plan, it would reemphasize the clear requirement for the military services
and defense agencies to process all receiving and acceptance reports and
other supporting payment documents electronically.

Background

The Small Business Act defines a small business concern as "one that is
independently owned and operated and which is not dominant in its field of
operation." 9 The law also states that in determining what constitutes a
small business, with respect to size standards, the definition will vary
from industry to industry to reflect industry differences accurately. 10
Over the years, SBA has established and revised numerical definitions for
all for-profit industries-which are matched to North American Industry
Classification System industries and referred to as SBA's size standards
table. Size standards in the table are almost always stated either as the
number of employees or average annual receipts of a business concern. In
addition to establishing eligibility for SBA programs, all federal
agencies must use SBA's size standards as criteria when awarding small
business contracts.

DOD plays a key role in the success of the federal government's small
business programs because it accounts for about two-thirds of all federal
procurements. The DOD Office of Small Business Programs (OSBP) is
responsible for DOD-wide small business policy and oversight to ensure
compliance by all military departments and defense agencies. OSBP is not
itself a procurement office but, instead, serves as a liaison between the
small business community and the DOD procurement offices. OSBP is
responsible for, among other things, advocating the use of small, small
disadvantaged, HUBZone, veteran owned, service-disabled veteran-owned, and
women-owned small businesses, and small business participation in SBA's
8(a) business development set aside program. This involves promoting small
business prime and subcontracting opportunities in accordance with federal
laws, regulations, and policies in an effort to meet statutory goals. OSPB
is not responsible for assisting small businesses in receiving timely
payments from DOD.

Prompt Payment Act Requirements

The Prompt Payment Act requires federal agencies to pay interest on
overdue invoices 11 and take discounts only when payments are made within
the allowed discount period. 12 The Prompt Payment Act implementing
regulations also generally prohibit paying invoices too early-specifying
that agencies may not make payments more than 7 days prior to the payment
due date, except under certain conditions. Agencies may use accelerated
payment methods under certain circumstances, including paying small
business invoices as quickly as possible once all required documentation
is received at the designated payment office. 13 The Prompt Payment Act
does not apply to contract financing payments-or the authorized payment of
monies prior to the acceptance of goods and services-including advance
payments, progress payments, payments on performance-based contracts, or
interim payments.

In general, payments covered by the Prompt Payment Act are due, unless
otherwise specified, (1) on the date specified in the contract, (2) in
accordance with the discount terms that are offered and taken, (3) in
accordance with accelerated payment methods, or (4) 30 days after the
start of the payment period. 14 If payments are not made according to the
above criteria, the government must pay interest penalty payments, and if
the interest penalty is not made, the contractor may demand an additional
penalty amount. These payments are calculated from the day after payment
was due until the day payment is made. 15 The rate used to calculate
interest penalties is established by the Secretary of the Treasury under
the Contract Disputes Act, 41 U.S.C. S: 611. As of January 1, 2006, the
rate was 5.125 percent. 16 The rate is calculated quarterly based on a
12-month rolling average of the Treasury Tax and Loan rate.

DOD's Commercial Payment Process

DOD's Defense Finance and Accounting Service (DFAS) has overall
responsibility for the payment of invoices related to goods and services
supplied by commercial vendors. These payments are made on behalf of the
military services and other defense agencies and are referred to as
commercial payments. As part of a reorganization effort in April 2001,
DFAS separated its commercial payment services into two business
lines-contract pay and vendor pay.

           o  DOD's contract pay business line is managed and operated out of
           DFAS-Columbus. The contract pay business line processes invoices
           for formal, long-term contract instruments that are typically
           administered by the Defense Contract Management Agency (DCMA).
           These contracts tend to cover complex, multiyear purchases with
           high dollar values, such as major weapon systems. Payments for
           contracts administered by DCMA are made from a single DFAS
           system-Mechanization of Contract Administration Services.

           o  DOD's vendor pay business line is managed and operated by 20
           separate DFAS sites located throughout the world. The vendor pay
           product line processes invoices for contracts not administered by
           DCMA, plus miscellaneous non-contractual payments, such as for
           utilities, uniforms/clothing, fuels, and food. Payments processed
           through the DOD vendor pay business line are made from any one of
           13 systems at the 20 vendor pay locations.

           In general, DFAS makes both vendor and contract payments only
           after matching the request for payment, or invoice, with (1) a
           signed contract, purchase order, or other contractual document-to
           ensure that the purchase of goods or services was authorized; (2)
           a receiving/acceptance report-to ensure that the goods or services
           ordered have been received and/or accepted; 17 and (3) the
           official accounting records-to ensure that funds have been
           obligated and are available for use. Because of DOD's numerous
           nonintegrated automated and manual systems, much of the data
           generated by these systems cannot be electronically transferred
           from one system to another in order to complete a payment
           transaction. Therefore, various data must be read, interpreted,
           and manually entered from hard copy documents-or manually verified
           and entered from electronic documents.

           As we have reported in the past, 18 DFAS management has focused on
           reducing commercial payment backlogs since fiscal year 2000 and
           has reported significant improvements in these payment metrics in
           recent years. However, many of these improvements have come from
           dedicating additional resources to the problem and not from
           addressing the underlying weaknesses or inefficiencies that cause
           late payments. In addition, as shown in figure 1, DOD's vendor pay
           payment backlog metrics continue to lag behind its contract pay
           metrics.

           Figure 1: Overdue Invoices on Hand as a Percentage of Total
           Invoices Processed for DOD's Vendor Pay and Contract Pay Business
           Lines for Fiscal Years 2001 through 2005

           As we have previously reported, 19 for the most part, both DOD's
           vendor payment and contract payment processes are paper
           driven-spanning numerous DOD and contractor organizations with
           nonintegrated procurement, logistics, and accounting systems.
           However, inherent differences in the type of payments made through
           DOD's vendor pay and contract pay processes result in significant
           differences in the timeliness of payments made through each of
           these processes.

           Although the payment processes for DOD's vendor pay and contract
           pay product lines require DOD to match key payment documents
           before an invoice can be paid, there is one major difference in
           the processes that allows DOD to pay invoices submitted through
           its contract pay process in a more timely fashion. Specifically,
           as part of DOD's contract pay process, the receipt and acceptance
           of goods and services is often performed by a government
           representative located at the contractor's facility-which is
           referred to as source acceptance. In contrast, under the vendor
           pay process, receipt and acceptance is usually performed after
           goods are received at their destination-which is referred to as
           destination acceptance. Consequently, the vendor pay process is
           more time consuming than DOD's contract pay process. It is
           important to note that source acceptance, while more efficient, is
           also more costly, and therefore it would not be practical to
           expand the use of this practice to the vendor pay product line.

Small Business Invoices Paid Late More Often Than All Invoices Paid at
Vendor Pay Locations

Our analysis of DOD's fiscal year 2004 payment data for nine DOD vendor
pay locations showed that to varying degrees, small business invoices were
paid late more often than all invoices paid at each of the nine vendor
payment locations. However, this disparity was not evident at DOD's
contract pay site, because efficiencies utilized by DOD's contract pay
business line result in more timely payments to contractors-including
small business contractors. As noted above, these same efficiencies cannot
be cost effectively applied to DOD vendor pay business line. Table 1 shows
the payment timing differences for the nine vendor pay locations and for
contract payments.

Table 1: Percentage of Invoices Paid Late by DFAS Location and Small
versus All Business for Fiscal Year 2004

DFAS payment    Percentage of small business  Percentage of all Percentage 
locations                 invoices paid late invoices paid late difference 
Vendor pay                                                      
Pensacolaa                             63.69              24.97      38.72 
Dayton                                 17.63              12.87       4.76 
San Diego                              10.11               9.62       0.49 
Norfolk                                14.43               9.04       5.39 
Rock Island                             9.24               8.92       0.32 
Charleston                             15.19               7.98       7.21 
Limestone                              10.83               7.24       3.59 
Orlando                                10.06               5.35       4.71 
Pacific                                 9.00               4.69       4.31 
Overall vendor                         14.43               9.94       4.49 
pay                                                             
Contract pay                                                    
Columbus                                1.72               1.78      (.06) 

Source: GAO analysis of DOD payment data.

aAccording to DFAS officials, the high percentage of invoices paid late by
the Pensacola vendor pay site was because of disruptions caused by
hurricanes that affected the region in 2004.

As discussed later, resolving this disparity will require the department
to improve the overall timeliness of payments made through DOD's vendor
pay business line. Further, given that DOD's vendor pay business line
presents the most significant challenge for DOD, with respect to paying
invoices on time, we focused specifically on the systemic weaknesses in
DOD's vendor payment processes and actions needed to improve the
timeliness of payments made through these processes.

Long-standing Weaknesses in DOD's Vendor Payment Processes Result in Late
Payments to Contractors, Including Small Business Contractors

Long-standing weaknesses in DOD's vendor payment processes-including DOD's
lack of automated systems-result in late payments to contractors,
including small business contractors. For decades, we have reported that
the leading cause of DOD late payments stems from delays caused by the
receiving and acceptance process. The delayed processing of these payment
documents is caused, in large part, by the paper-driven nature of DOD's
vendor payment process and DOD's nonintegrated payment, accounting, and
logistics systems. As discussed previously, small business invoices are
paid late more often than all invoices paid at selected vendor payment
locations, which according to DOD officials, may occur because of DOD's
cash management and prioritization practices. Resolving this disparity
will require the department to improve the overall timeliness of payments
made through DOD's vendor pay business line. To its credit, DOD has
invested in Web-based business tools that facilitate the electronic
transmission of payment documents and data. If implemented and used
effectively, these tools could improve the timeliness of DOD's vendor
payments; however, DOD has been slow to implement and use these tools.

DOD's Cash Management Practices May Disadvantage Small Businesses

DOD vendor pay officials told us that they were unaware that small
business invoices were paid late more often than all invoices and were
uncertain as to the cause of the disparity. However, some officials
suggested that the difference may occur because DOD's cash management
practices inadvertently disadvantage small businesses by placing a lower
priority on the payment of smaller, less-complex invoices, like those
typically submitted by small business contractors. In addition, none of
the vendor pay sites we visited were following DOD's written policy to
assist small disadvantaged businesses 20 by paying them as quickly as
possible after invoices are received and before normal payment due dates
established in the contract.

DOD's vendor pay sites prioritize the payment of invoices based on the
amount of the invoice, the payment due date, and whether the contractor
has offered an early payment discount. 21 While these priorities are based
on sound cash management practices, they tend to favor the payment of
non-small business invoices first. In addition, DOD's vendor pay sites
prioritize their workload based on the overall complexity of an invoice
and the anticipated time it will take to process the invoice. For example,
large multimillion-dollar invoices may contain over 100 lines of
accounting-or separate funding sources for each billable item. Each line
of accounting must be matched with the receiving report, contract terms,
and accounting records to ensure proper payment of the invoice-making it
time-consuming to process these invoices. These complex invoices are not
typically associated with small businesses. It is important to note that
these same practices are also used at DOD's contract pay site but did not
result in a timing disparity between the payment of small business and all
invoices.

Finally, it is DOD's written policy to assist small disadvantaged
businesses by paying them as quickly as possible after invoices are
received and before normal payment due dates established in the contract.
However, at the vendor pay sites we visited, the automated systems used to
process payments did not contain the demographic information needed to
identify small disadvantaged businesses and prioritize the payment of
their invoices. According to DOD vendor pay officials, it was too costly
to change the vendor payment system requirements to accommodate the needed
information. As a result, none of the vendor pay sites we visited had
implemented DOD's policy to pay small disadvantaged businesses as quickly
as possible after their invoices are received.

Electronic Commerce Tools Could Improve the Timeliness of Payments Made
through DOD's Vendor Payment Process

To its credit, DOD has invested in the Web-based tool know as WAWF, which,
if implemented and used effectively, could improve the overall timeliness
of payments made through DOD's vendor pay business line by facilitating
the electronic transmission of payment documents and data. However, DOD's
WAWF program lacks the management information and strategic direction
needed to be successful. Specifically, DOD lacks the metrics needed to
know whether WAWF is being utilized and, if not, what the barriers are to
more effective utilization. In addition, the program management of this
initiative has changed hands numerous times, lacks the organizational
authority to effect change across DOD, and does not have a written
strategy for ensuring that WAWF will be effectively utilized. As a result,
DOD's vendor payment sites continue to process mostly paper payment
documents, which can often result in redundant data entry; misplaced
documents; and ultimately, payment delays.

Until recently, the computer-to-computer exchange of routine business
information, known as Electronic Data Interchange (EDI), was the
predominant electronic commerce technology available to both government
and industry. Using EDI technology, invoices and other payment
documents-traditionally conveyed in paper form-can be transmitted
electronically between computers without human intervention. However, to
implement EDI technology, data must be converted into a standard data
format before it is transmitted to the receiving system. Because the cost
of converting and transmitting business data was prohibitively expensive
for small and midsized companies, most small businesses continued to
convey paper documents by mail or facsimile (fax).

With the arrival of Web-based business tools, the electronic exchange of
data has become more cost-effective for many smaller businesses.
Accordingly, the Congress included a requirement in the Floyd D. Spence
National Defense Authorization Act for Fiscal Year 2001 22 that the
Secretary of Defense shall require any claims for payment (e.g., invoices)
under DOD contracts be submitted in electronic form. 23 In January 2004,
DOD updated the Defense Federal Acquisition Regulation Supplement (DFARS)
to reflect the new electronic invoicing requirement. 24 The January 2004
DFARS update outlines the electronic submission options 25 and provides
for exceptions to the regulation when (1) the contractor is unable to
submit a payment request in electronic form or (2) DOD is unable to
receive a payment request in electronic form.

DOD deployed the first version of WAWF in fiscal year 1999 with the goal
of eliminating paper from the payment process by enabling authorized
defense contractors and DOD personnel to create and transmit electronic
invoices and receiving reports and access contract-related documents
online. According to DOD officials, WAWF is intended to be a major
component of the department's compliance with the electronic invoicing
requirements of the fiscal year 2001 National Defense Authorization Act
and contribute to the department's goal of reducing interest charges for
late payments to vendors. Specifically, WAWF provides DOD with the
capability to automatically update its payment systems to complete the
payment transaction without human intervention-which could significantly
improve the timeliness of payments. Under DOD's current vendor payment
process, these paper documents may arrive at the DFAS payment office
separately-typically by mail or by fax. DFAS vendor payment technicians
then process each document as it arrives by manually keying it into the
payment system.

WAWF, if fully implemented and utilized as planned, can eliminate paper
and redundant data entry; improve data accuracy; reduce the number of lost
or misplaced documents; and ultimately, result in more timely payments to
contractors. Further, this tool is available to all of DOD's contractors
at no cost and provides electronic confirmation that the payment office
has received payment documents and allows contractors to track the status
of their payments. WAWF, according to DOD, also provides direct financial
savings to the military services. Because processing electronic invoices
is less costly for DFAS than processing paper invoices, the military
service activities that use WAWF will pay a reduced payment processing
service fee. For example, according to DOD, processing an electronic
invoice for the U.S. Navy Bureau of Medicine and Surgery (BUMED) costs
$3.66 per line of accounting 26 whereas a paper invoice costs $19.08. By
using WAWF, BUMED estimated that it could reduce the amount it pays DFAS
to process its invoices and save about $2.78 million per year. Other
direct savings may be realized because of reductions in the amount of
prompt payment interest paid. According to DOD, when the Air Force Air
Education and Training Command implemented WAWF it realized a 45 percent
decrease in the amount of interest penalties paid resulting from late
payments.

According to DOD, WAWF has produced promising results when it is
effectively utilized. However, the program lacks the strategic direction
and management information needed to ensure its success. DOD's WAWF
program has been managed by the Defense Information Systems Agency (DISA)
since it was placed in operation in fiscal year 1999 but according to the
current program manager, this position has changed hands three times since
fiscal year 2003-at times, with no one filling the position. In October
2005, with the establishment of the Defense Business Transformation Agency
(BTA)-which is intended to advance DOD-wide business
transformation-ownership of the WAWF initiative was transferred to BTA.
However, as of the date of this report, although ownership has been
officially transferred to BTA, DISA, in effect, continues to manage WAWF.
Moreover, DISA's primary focus has been on addressing technical issues
that affect WAWF functionality-not on ensuring that the application is
effectively utilized by contractors or the military services.

Although other DOD organizations, such as DFAS and DCMA, and the military
services have established implementation points of contact who have
initiated efforts to market WAWF and provide training, their focus has
been almost entirely on implementing WAWF in the contract pay arena. Less
emphasis has been placed on implementing WAWF in the vendor pay business
line. Further, DOD does not have a comprehensive written strategy for how
it intends to ensure that contractors routinely submit their invoices
electronically or that the military services submit receiving and
acceptance reports electronically. Because DOD's vendor pay process relies
almost exclusively on destination acceptance, it is important that
military service and defense agency receiving units designate and train
WAWF focal points who will be responsible for receiving and accepting
goods and services electronically. However, military service and defense
agency receiving units have been slow to embrace WAWF as a means of
performing receipt and acceptance activities. As such, a comprehensive
strategy for addressing this and other challenges that may adversely
affect WAWF utilization is essential.

Although DOD has equipped 14 of its 20 vendor payment locations with WAWF,
DOD does not collect the management information needed to effectively
measure the success of this initiative. For example, the WAWF program
manager did not know the percentage of vendor pay invoices received
electronically or the percentage of vendor pay receiving/acceptance
documents received electronically, or to what extent the military services
had equipped and trained their receiving units to use WAWF. DFAS officials
at the vendor pay sites we visited also did not keep track of these
metrics but estimated that they receive, at most, 20 percent of their
invoices electronically and even fewer receiving/acceptance reports. Even
with the small number of payment documents processed through WAWF, vendor
pay officials complained of the application's slow processing
speed-stating that they were not sure if the application could handle a
larger workload. As a result, these officials said that they were
reluctant to encourage the use of WAWF. According to the WAWF program
manager, the problems experienced by these vendor pay locations have been
resolved and were likely caused by the latest application upgrade.

Finally, the legal and regulatory requirement for the military services
and defense agencies to process receiving and acceptance reports and other
supporting documentation electronically may not apply to the majority of
invoices submitted through DOD's vendor payment process. Specifically, the
electronic invoicing provisions included in the National Defense
Authorization Act for Fiscal Year 2001 states that DOD officers or
employees who receive an electronic invoice from a DOD vendor, and who
also must transmit the invoice to another DOD officer or employee for
payment processing, must transmit the claim and any supporting
documentation electronically (e.g., receiving reports). However, most
vendor pay contractors submit their invoices directly to DFAS for payment
27 and rely on the military service or defense agency receiving unit to
send receiving and acceptance documents to DFAS. Thus, when a vendor pay
contractor submits an electronic invoice to DFAS, DOD does not require
military service or defense agency receiving units to acknowledge receipt
and acceptance electronically.

Although DOD policies encourage the electronic transmission of receiving
reports and other supporting documentation, DOD's implementing regulations
and policies do not clearly extend this requirement to receiving and
acceptance officials. 28 While requiring contractors to submit invoices
electronically is a good first step toward improving DOD's payment
process, electronic invoicing alone does not address DOD's biggest
obstacle to paying its bills on time-the timely submission of receipt and
acceptance documents. As a result, according to DOD vendor pay officials,
they continue to receive most of these documents by mail or fax, which can
often result in redundant data entry, misplaced documents, and ultimately,
payment delays.

Late Payments May Create Financial Hardship for Some Small Business
Contractors

Although DOD is required by the Prompt Payment Act to pay interest
penalties when certain bills are paid late, 29 the amount of interest
received is less than small businesses' cost of capital and may also
affect cash flow. As a result, the disruption of cash flow caused by late
payments can have a significant impact on the day-to-day operations of
small businesses. Further, many of the small business contractors we
interviewed said that they often did not receive interest on invoices that
in their view, were paid late. In an effort to substantiate the
contractors' assertions, we requested documentation from DFAS for late
payments for the three small business contractors that provided us with
information they believed demonstrated that they were owed interest.
However, DFAS was unable to provide us with the requested documentation,
and therefore, we were unable to confirm the contractors' assertions.

To obtain a perspective on the effect late payments have on small business
contractors, we interviewed 17 small business owners who, according to
DOD's records, were paid late multiple times during fiscal year 2004. At
these interviews, 14 of the 17 small business owners said that because DOD
pays its bills late, they have had to obtain lines of credit or use their
personal resources to finance day-to-day operations. In three cases,
contractors told us that their cash flow problems became so significant
that they were concerned about their ability to continue in operation.
Although DOD is required by the Prompt Payment Act to pay interest penalty
payments when certain bills are paid late, the amount of interest received
is less than these small businesses' cost of capital. Eleven of the 14
small business owners who had obtained a line of credit said that a line
of credit cost them 2 to 4 percentage points more than the interest rate
DOD uses to calculate late payment penalties. For example, using the
prompt payment rate of 4.25 percent, which was in effect as of June 2005,
DFAS paid interest of $199 to 1 small business contractor on an $84,150
invoice paid 20 days past its due date. However, financing $84,150-using
the 7.250 percent interest rate available through the contractor's line of
credit-would cost the small business owner $340.

The difference between the prompt payment interest rate and interest rates
obtained by the small business owners we spoke with is consistent with
government statistics on lending rates. Over the 10-year period between
1995 and 2004, the prompt payment interest rate was on average 5.8
percent, whereas the average prime lending rate-the interest rate charged
by major banks to their best or most creditworthy customers-was 7.1
percent. Cash flow problems experienced by these DOD small business
contractors are also consistent with the findings of a survey of
small-business owners conducted by the Federal Reserve and the National
Federation of Independent Businesses (NFIB). 30 The results of the NFIB
survey showed that outstanding receivables are the primary reason small
businesses experienced cash flow problems.

Table 2 provides an overview of the types of pay problems described by 8
of the 17 small business owners we interviewed. As discussed previously,
the problems described by these 8 small business contractors may not be
representative of all DOD small business contractors. As shown in table 2,
DOD records showed that 5 of the 8 were paid late more than 15 times and,
according to 6 of the 8 small business owners, they had outstanding
invoice amounts totaling at least $400,000 as of the date we interviewed
them.

Table 2: Case Study Examples of Small Business Invoices Paid Late by DFAS

Small business         Number of Receivables > Payment        Consistently 
                               late 30 days as of problems       received     
                        payments in   the date of identified by  interest     
                        fiscal year           our small          payments on  
                               2004    fieldworka businesses     overdue      
                                                                 receivables  
Case study 1: 8(a),            5      $491,782 Invoices lost  Yes          
small disadvantaged                            by DFAS,       
business providing                             resulting in   
promotional and                                continual      
recruiting items for                           follow-up to   
the Army                                       receive        
                                                  payments       
Case study 2: 8(a),           17      $755,951 Cumbersome,    No           
small disadvantaged                            inefficient    
business providing                             process;       
environmental                                  current        
remediation services                           contractual    
for the Navy                                   documents not  
                                                  available in   
                                                  payment office 
Case study 3: 8(a),           63      $431,920 Invoices lost  Yes          
small disadvantaged                            by DFAS,       
business providing                             resulting in   
construction                                   continual      
services for the Air                           follow-up to   
Force and the Navy                             receive        
                                                  payments       
Cast study 4: 8(a),           22      $570,899 Invoices lost  No           
small disadvantaged                            by DFAS,       
business providing                             resulting in   
environmental                                  continual      
engineering services                           follow-up to   
for the Army and the                           receive        
Navy                                           payments; poor 
                                                  customer       
                                                  support when   
                                                  trying to      
                                                  resolve issues 
Case study 5: 8(a),           23      $743,000 Invoices lost  Yes          
small disadvantaged                            by DFAS,       
business providing                             resulting in   
general maintenance                            continual      
and construction                               follow-up to   
services for the                               receive        
Army and the Navy                              payments       
Case study 6:                361      $286,760 Invoices lost  No           
minority owned small                           by DFAS,       
business providing                             resulting in   
moving and storage                             continual      
services for the                               follow-up to   
Army                                           receive        
                                                  payments       
Case study 7: small            1      $600,000 Receiving unit No           
business providing                             failed to      
computer software                              submit         
and equipment for                              receiving      
the Army                                       report in a    
                                                  timely manner  
Case study 8:                  2      $140,000 Invoices lost  No           
minority owned,                                by DFAS,       
8(a), small                                    resulting in   
disadvantaged                                  continual      
business providing                             follow-up to   
facilities                                     receive        
management services                            payments;      
for the Army and the                           cumbersome,    
Navy                                           inefficient    
                                                  process.       

Source: GAO analysis of DOD and vendor data.

aWe interviewed small business owners from June 2005 through September
2005 and obtained outstanding balance information as of the date of our
interview.

Although DOD is required by the Prompt Payment Act to pay interest penalty
payments when certain bills are paid late, 10 of the 17 small business
owners we spoke with said that they did not receive interest payments when
they were paid late. For example, 1 contractor provided us with
information on 10 invoices totaling $755,951 that were submitted during a
5-month period in 2005. Although, based on the contractor's records, each
invoice was paid from 7 to 125 days late, according to the contractor, no
interest was ever received. In an effort to substantiate these assertions,
we requested documentation from DFAS for late payments that according to
these contractors, should have resulted in interest penalty payments.
Specifically, we requested a copy of the invoice and receiving and
acceptance documents for 20 examples of late payments provided by 3 small
business contractors for which, according to the contractors, no interest
was received. DFAS, however, was unable to provide us with the
documentation we requested. Nonetheless, according to 1 of the small
business owners, after we asked DOD to research the contractor's
assertions, DOD determined that the contractor was entitled to interest
penalty payments of approximately $1,000-which, according to the
contractor, DOD later paid. According to DFAS officials, interest was not
paid on these invoices previously because DFAS entered the wrong invoice
dates into the payment system. As discussed later, the invoice date
entered into the payment system is used to establish payment due dates.

As shown in table 2, from the small business contractors' perspective, the
biggest challenge they face in getting paid is ensuring that DFAS receives
and acknowledges receipt of the invoices they submit. Nine of the 17 small
business owners we interviewed told us that they had to submit their
invoices to DFAS multiple times before DFAS acknowledged receipt of the
invoice. According to most of the contractors we spoke with, they
submitted their invoices by fax-often transmitting the same invoice to
DFAS multiple times before DFAS acknowledged receipt of the invoice by
date stamping it and subsequently processing it for payment. This is
significant in that DFAS establishes payment due dates based on the date a
proper invoice is received by the payment office. 31 If days and weeks go
by-as it was described to us-before contractors' invoices are successfully
received by the payment office, it would explain why, from the
contractors' perspective, they believed that they were entitled to
interest payments that they did not receive. According to DFAS officials,
because DFAS has no visibility over hard copy invoices until they are
entered into the payment system, the time lag between the receipt of a
hard copy invoice and its entry into the payment system could lead
contractors to believe that DFAS had lost their invoice.

As discussed previously, WAWF, if implemented and used effectively, would
eliminate the problem of lost invoices and provide a mechanism by which
small business contractors could track the status of their invoices online
and possibly be paid earlier. However, most of the small business owners
we interviewed said that they had never heard of WAWF, and only 4 of the
17 contractors we interviewed were using WAWF. According to these 4 small
business owners, using WAWF did resolve payment delays related to lost
invoices but did not resolve the problem of late payments. Because DOD
also requires acknowledgment of the receipt and acceptance of goods and
services-over which contractors have little control-and the military
service and defense agency receiving units responsible for receipt and
acceptance do not routinely utilize WAWF, these contractors will likely
continue to experience payment delays.

Conclusion

DOD has made significant progress in recent years in reducing its reported
backlog of overdue invoices and improving its overall metrics related to
late vendor payments. However, many of these improvements have come from
focusing additional resources on the problem and not from addressing the
underlying weaknesses that cause late payment. Although DOD has embarked
on a series of efforts over the last decade to modernize its business
systems-in an effort to address the underlying weaknesses in its vendor
payment processes that we identified in our report-these efforts have been
largely unsuccessful. With advances in Web based technology, DOD now has
the opportunity to address some of these weaknesses and improve its
ability to pay its contractors on time-including small business
contractors. However, fully implementing and effectively utilizing WAWF
will require sustained leadership and a focused strategy aimed at ensuring
the successful implementation and utilization of available electronic
commerce tools.

Recommendations for Executive Action

We recommend that the Secretary of Defense direct the Director of the
Defense Business Transformation Agency to take the following four actions
to clarify the management structure and policies over WAWF:

           o  Provide strategic direction for DFAS, DCMA, DISA, the military
           services, and defense agencies in their efforts to fully implement
           and effectively utilize WAWF.
           o  Establish a strategic plan that defines the roles and
           responsibilities of the various organizations that are integral to
           the success of the program and outlines a strategy for improving
           the utilization of WAWF-including correcting WAWF functionality or
           processing issues that may hamper effective utilization.
           o  Develop performance metrics that enable the department to
           measure the success of the program-including comprehensive metrics
           on the volume of invoices and receiving documents transmitted
           electronically.
           o  Consider incorporating, as part of the WAWF application, a data
           element that would flag invoices submitted by small disadvantaged
           business so that they may be paid more expeditiously, in
           accordance with DOD policy.

           To help ensure that the military services and defense agencies
           effectively utilize WAWF we also recommend that the Secretary of
           Defense take the following action:

           o  Establish a clear requirement that the military services and
           defense agencies process all receiving and acceptance reports and
           other supporting payment documentation electronically.

Agency Comments and Our Evaluation

In written comments, which are reprinted in appendix I, DOD concurred with
our recommendations and noted that the recent transition of WAWF to BTF
will provide a renewed opportunity to address the strategic direction and
planning to ensure that this program is fully implemented and effectively
utilized. According to DOD, it plans to evaluate and revisit existing WAWF
metrics and consider including, as part of its next WAWF requirements
review, a data element that would flag invoices submitted by small
disadvantaged businesses. DOD also stated that, as part of its strategic
plan, it would reemphasize the clear requirement for the military services
and defense agencies to process all receiving and acceptance reports and
other supporting payment documents electronically.

We are sending copies of this report to the Secretary of Defense,
interested congressional committees, and other interested parties. We will
make copies of the report available to others upon request. In addition,
the report is available at no charge on GAO's Web site at
http://www.gao.gov.

If you or your staff have any questions about this report, please contact
me at (202) 512-9095 or [email protected] . Contact points for our
Offices of Congressional Relations and Public Affairs may be found on the
last page of this report. GAO staff who made major contributions to this
report were Diane Handley, Assistant Director; Francine DelVecchio; and
Jamie Haynes.

McCoy Williams Director, Financial Management and Assurance

List of Congressional Committees

The Honorable John Warner Chairman The Honorable Carl Levin Ranking
Minority Member Committee on Armed Services United States Senate

The Honorable Ted Stevens Chairman The Honorable Daniel K. Inouye Ranking
Minority Member Subcommittee on Defense Committee on Appropriations United
States Senate

The Honorable Duncan L. Hunter Chairman The Honorable Ike Skelton Ranking
Minority Member Committee on Armed Services House of Representatives

The Honorable C.W. Bill Young Chairman The Honorable John P. Murtha
Ranking Minority Member Subcommittee on Defense Committee on
Appropriations House of Representatives

Appendix I: Comments from the Department of Defense Appendix I: Comments
from the Department of Defense

Appendix II: Objectives, Scope, and Methodology Appendix II: Objectives,
Scope, and Methodology

To determine whether small businesses were more likely to be paid late
than all businesses, we requested transaction-level detail for all DOD
commercial payments subject to the Prompt Payment Act and all interest
penalties paid in fiscal year 2004. For fiscal year 2004, DOD reported
total payments subject to the Prompt Payment Act of $206 billion-of which
$119 billion were paid through DOD's contract pay business line and $87
billion were paid through its vendor pay product line. We received all the
payment data requested for DOD's contract payment business line. However,
DOD was able to provide payment data for only 9 of its 20 vendor payment
locations. The payments generated from these 9 locations represent $24
billion, or approximately 28 percent, of the total $87 billion in vendor
payments that were subject to the Prompt Payment Act.

Using the payment data from the nine vendor pay locations and one contract
pay location, combined with data we obtained from the Central Contractor
Registration (CCR) database-which contains the most comprehensive listing
of small business contractors-we calculated the extent to which small
businesses are paid late as compared with the payment of all invoices.
Specifically, we used the data from CCR to identify invoice and interest
payments associated with small business contractors. However, payment data
for the nine sites did not always contain complete identifier data, which
would allow us to determine whether the transaction involved a small
business; some sites contained fairly complete data and others were
missing identifiers for a large percentage of transactions. Because we
were not able to identify all small businesses, our calculations compare
invoices from known small businesses to invoices from all companies. To
determine the percentages of invoices paid late, we divided the number of
invoices paid late by the total number of invoices paid during the same
period.

To examine the potential impact of the missing identifier data on our
analyses, we calculated and compared late payment rates in a number of
ways: comparing invoices from known small businesses with invoices from
all businesses, comparing invoices from known small businesses with the
remaining invoices (excluding known small businesses), comparing invoices
from known small businesses with the remaining invoices after designating
the transactions with missing identifiers to be in equivalent proportion
to the known small and known non-small businesses, and comparing invoices
from known small businesses to the known non-small businesses-after all
transactions with missing identifiers were removed. In all cases, the
overall finding that small business invoices were more likely to be paid
late remained consistent. This finding also remained relatively consistent
between sites that had more complete data and sites that did not. We also
discussed with DFAS officials the reasons why identifier information was
missing. The reasons included removal during the archive process and lack
of a requirement for that field in particular systems. We found no
evidence that the missing identifiers were caused by systematic
differences in how data on transactions from small versus non-small
businesses are maintained.

To ensure that the DOD data were sufficiently reliable for our analyses,
we conducted detailed reliability assessments of the data sets that we
used. We restricted these assessments, however, to the specific variables
that were pertinent to our analyses. We assessed the reliability of the
payment data obtained from DOD's payment systems by ensuring that the
transaction detail provided was consistent with summary totals reported as
part DOD's prompt payment metrics. We also assessed the reliability of
these data by performing nonstatistical sampling. To accomplish this,
individual transactions were selected on a judgmental basis. Attributes
from these transactions were compared to the original, supporting
documentation held at the respective DFAS service center that processed
the transaction. We reviewed attributes such as dates, contract numbers,
amounts, and ensured policies related to the payment process were met
prior to disbursement of funds. As part of our data reliability assessment
we also considered the risk that contractors are misclassified (large
versus small business) in the CCR database. We believe the risk is small
for two reasons. First, the Small Business Administration (SBA) verifies
the small business status of contractors that are part of SBA's set aside
program-which is the primary means by which DOD meets its annual small
business procurement goals. Second, according to SBA, small business
self-certification is policed by other small business contractors-who have
a vested interest in the accuracy of the small business designation. We
found that all the data sets used for this report were sufficiently
reliable for use in our analyses.

To determine the cause of late payments, we performed audit work at six
DFAS vendor payment locations and the DFAS contract pay site, which
collectively represent $169 billion, or 82 percent of all payments subject
to the Prompt Payment Act. The payments generated from the six vendor pay
locations represent $50 billion, or approximately 58 percent, of the total
vendor payments that were subject to the Prompt Payment Act. At each of
the DFAS service sites visited, we interviewed officials who were
responsible for processing vendor invoices for payment; officials who
prepared and submitted metrics related to the overall timeliness of
payments made; and officials who were responsible for handling both large
and small business contractor complaints and inquiries. Additionally, we
obtained documentation on and performed walk-throughs of the vendor
payment and contract payment processes.

We selected DFAS vendor pay sites for review based on the percentage of
interest penalty payments made compared to the total amount of payments
made subject to the Prompt Payment Act. Once this percentage was
determined, we chose DFAS vendor pay sites with both disproportionately
high and low percentages compared to the average percentage for all sites.
Sites with low percentages were selected because of their relative
proficiency in paying vendors in a timely manner and to identify possible
best practices used by these sites. Sites with high percentages were
chosen so that we could understand and document problems associated with
the payment process. Further, the site selection criteria ensured that
service-unique processes and locations were included. The DFAS vendor pay
sites we visited are as follows: Columbus, Ohio; Dayton, Ohio; Norfolk,
Virginia; Rock Island, Illinois; San Diego, California; and Indianapolis,
Indiana.

To gain an understanding of how DFAS and DISA coordinated, managed, and
implemented the WAWF program, we interviewed the DFAS WAWF focal point,
officials responsible for collecting electronic commerce metrics at DFAS,
and the WAWF program manager. We obtained and analyzed memorandums,
directives, briefings, and other documents related to the WAWF
program-including system requirements documentation describing the
functionality of the current version of WAWF, version 3.0.9.

To document the criteria governing payments to small business contractors,
we obtained and reviewed applicable policies, procedures, and program
guidance, including the Small Business Act, 1 the Prompt Payment Act and
regulations, 2 the Defense Federal Acquisition Regulations, 3 the Federal
Acquisition Regulation, 4 and DFAS desk policies. In conducting our work,
we also referred to the internal control standards provided in Standards
for Internal Control in the Federal Government. 5

To assess the impact that late payments have on small business
contractors, we relied on a case study approach, principally because DOD
was unable to provide us with a complete universe of small business
contractors that were paid late, which would be needed to perform sampling
techniques that would allow us to comment on the experiences of small
business contractors as a whole. Therefore, using DOD payment and other
data, we identified small business contractors that were paid late
multiple times during fiscal year 2004 and documented the difficulties
experienced by 17 of these contractors. We selected our case study
examples from the DOD payment data provided by identifying small business
contractors that DOD paid late most frequently. Of those small business
contractors that were paid late most frequently, 17 expressed a
willingness to share information on late payments with us. Our findings
for this objective cannot be projected and may not be representative of
the experiences of DOD small business contractors as a whole. We
interviewed each of these contractors from June 2005 through September
2005 and, when possible, obtained documentation related to late payments,
including accounts receivable aging reports and copies of unpaid invoices.
In addition, we attempted to corroborate contractors' claims that they had
not received interest payments to which they believed they were entitled
by requesting from DFAS invoices, receiving reports, and any other payment
documentation related to these claims.

(192151)

We briefed DFAS and DOD officials from the selected payment locations on
the details of our audit, including findings and their implications. We
conducted our fieldwork from November 2004 through January 2006 in
accordance with U.S. generally accepted government auditing standards. We
requested comments on a draft of this report from the Secretary of Defense
or his designee. We received written comments from the Deputy Under
Secretary of Defense (Business Transformation). These comments are
evaluated in the "Agency Comments and Our Evaluation" section of this
report and are reprinted in appendix I.

GAO's Mission

The Government Accountability Office, the audit, evaluation and
investigative arm of Congress, exists to support Congress in meeting its
constitutional responsibilities and to help improve the performance and
accountability of the federal government for the American people. GAO
examines the use of public funds; evaluates federal programs and policies;
and provides analyses, recommendations, and other assistance to help
Congress make informed oversight, policy, and funding decisions. GAO's
commitment to good government is reflected in its core values of
accountability, integrity, and reliability.

Obtaining Copies of GAO Reports and Testimony

The fastest and easiest way to obtain copies of GAO documents at no cost
is through GAO's Web site ( www.gao.gov ). Each weekday, GAO posts newly
released reports, testimony, and correspondence on its Web site. To have
GAO e-mail you a list of newly posted products every afternoon, go to
www.gao.gov and select "Subscribe to Updates."

Order by Mail or Phone

The first copy of each printed report is free. Additional copies are $2
each. A check or money order should be made out to the Superintendent of
Documents. GAO also accepts VISA and Mastercard. Orders for 100 or more
copies mailed to a single address are discounted 25 percent. Orders should
be sent to:

U.S. Government Accountability Office 441 G Street NW, Room LM Washington,
D.C. 20548

To order by Phone: Voice: (202) 512-6000 TDD: (202) 512-2537 Fax: (202)
512-6061

To Report Fraud, Waste, and Abuse in Federal Programs

Contact:

Web site: www.gao.gov/fraudnet/fraudnet.htm E-mail: [email protected]
Automated answering system: (800) 424-5454 or (202) 512-7470

Congressional Relations

Gloria Jarmon, Managing Director, [email protected] (202) 512-4400 U.S.
Government Accountability Office, 441 G Street NW, Room 7125 Washington,
D.C. 20548

Public Affairs

Paul Anderson, Managing Director, [email protected] (202) 512-4800 U.S.
Government Accountability Office, 441 G Street NW, Room 7149 Washington,
D.C. 20548

www.gao.gov/cgi-bin/getrpt? GAO-06-358 .

To view the full product, including the scope

and methodology, click on the link above.

For more information, contact McCoy Williams at (202) 512-9095 or
[email protected].

Highlights of GAO-06-358 , a report to congressional committees

May 2006

DOD PAYMENTS TO SMALL BUSINESSES

Implementation and Effective Utilization of Electronic Invoicing Could
Further Reduce Late Payments

The National Defense Authorization Act for Fiscal Year 2004 requires GAO
to report on the timeliness of Department of Defense (DOD) payments made
to small businesses. GAO's report focuses on (1) whether, at DOD payment
centers for which data were available, small business invoices were more
likely to be paid late; (2) whether systemic weaknesses in DOD payment
processes result in late payments to contractors-including small business
contractors; and (3) the impact of late payments on small businesses. To
calculate timeliness rates, GAO used the data DOD was able to provide for
9 of its 20 vendor payment locations as well as its one contract pay
location. GAO used a case study approach for the third objective because
data limitations did not permit the use of statistically reliable sampling
techniques for assessing the experiences of DOD small business contractors
as a whole. Case study contractors were selected because they experienced
a high frequency of late payments and may not be reflective of all small
businesses.

What GAO Recommends

GAO makes five recommendations to strengthen the implementation of a
Web-based tool known as Wide Area Work Flow (WAWF), which could speed the
processing of payment documents and improve the timeliness of DOD
payments, including payments to small businesses. DOD concurred with GAO's
recommendations.

DOD paid small business invoices late more often than all invoices paid at
the nine locations for which data were available. Ten percent of all
invoices at these locations were paid late-compared with 14.5 percent of
small business invoices. According to DOD officials, the disparity may
have occurred because DOD's cash management and prioritization practices
tend to favor paying larger vendors first. Although DOD has reported
significant improvements in its metrics related to late payments, these
improvements have come through dedicating additional resources to the
problem and not through addressing the underlying weaknesses that cause
late payments. Resolving the payment timing disparity will involve
improving the overall timeliness of DOD payments to contractors regardless
of size.

Systemic weaknesses in DOD's payment processes result in late payments to
contractors, including small business contractors. DOD continues to
process mostly paper payment documents, which can often result in
redundant data entry; misplaced documents; higher than necessary
transaction processing fees; and ultimately, payment delays. To its
credit, DOD has invested in a Web-based tool, WAWF, that could facilitate
the electronic exchange of payment data and documents, but the initiative
lacks the requisite management focus and strategic direction needed to be
successful. For example, the WAWF program lacks performance metrics and
does not have a clear strategy for ensuring that WAWF will be effectively
utilized. Finally, in many cases, the military services and defense
agencies are not required to acknowledge receipt and acceptance
electronically. Instead, they submit paper documents that must be matched
with contractor invoices to complete the payment transaction, which can
lead to payment delays.

Disruptions of cash flow caused by late payments-depending on the extent
and duration-can significantly affect the day-to-day operations of small
businesses. To illustrate, GAO interviewed 17 small business owners that
were paid late multiple times during fiscal year 2004. They provided the
following perspectives:

           o  Fourteen of the 17 said that because DOD paid late, they had to
           obtain a line of credit or use personal resources to finance
           day-to-day operations.
           o  Eleven of the 14 that relied on a line of credit said that they
           paid 2 to 4 percent more for the credit than the rate used by DOD
           to calculate late payment interest.
           o  In 3 cases, contractors said that their cash flow problems were
           so significant that they were concerned about their ability to
           stay in operation.

Although the Prompt Payment Act requires interest payments when certain
bills are paid late, 10 contractors stated that they often did not receive
interest on late payments. GAO could not substantiate these statements
because DOD was unable to provide the information needed to do so.
According to one contractor, after GAO asked DOD to research his claim,
DOD determined that the contractor was entitled to interest of about
$1,000.
*** End of document. ***