Defence's single biggest challenge over the next year will be to deliver agreed strategic objectives if budget volatility continues, department secretary Dennis Richardson says.
In an apparent warning to the new government, Mr Richardson said defence made some hard financial choices over the last year in order to meet government expectations.
He said defence pursued a strategy to protect personnel and operations and minimise impact on core capabilities. It prioritised investments and reduced administration costs, but budget volatility made all that difficult.
"The single biggest challenge for the next 12 months will be the department's ability to continue to deliver agreed strategic objectives should budget volatility continue," Mr Richardson said in the Defence annual report for 2012-13.
Last year, the Labor government pared defence spending in the hope of achieving a budget surplus. The coalition opposition said defence spending had fallen to crisis levels.
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In the May budget, the Labor government gave up on a surplus and handed some funds back to defence, taking spending to $25.4 billion - growth of 2.3 per cent - with the promise of more to come.
The coalition has promised to lift defence spending with an aspiration to spend two per cent of GDP, when the budget situation allows.
The defence annual report shows the defence force became smaller, with 56,117 in the uniformed force - a reduction of 1168 in a year - and 21,006 in the defence public service - a reduction of 1278.
