Training costs pound;5,000 per recruit. With a third failing to stay in the Army, it "probably wastes about pound;30 million a year on drop-outs".
Some recruits could be prevented from dropping out if they were given a better insight into army life before joining, say the inspectors.
The report, titled "Safer Training", says the armed forces should apply civilian management techniques to their training programmes, provide commanding officers with longer postings at training establishments, and promote training by offering rewards and promotions for those who provide it.
Inspectors say the armed forces should also reduce the number of training establishments to ensure better standards and staffing.
The report says: "A young person's initial contact with the armed forces was usually in attractive modern offices, often in stark contrast to the training environment they found themselves in later."
Some recruits would end up living in barracks that were "little better than slums".
The report also criticises the Army for failing to recruit enough people from some ethnic minority groups.
David Sherlock, chief inspector of the ALI, said that the inspectorate was surprised to find so few recruits from British ethnic minority communities "who, 50 years ago, would have been the pride of the British Army in India and other parts of the world".
Members of ethnic minorities who sign up are likely to find racist taunts dismissed as "banter" or "nicknames", says the report.
It adds: "Comprehensive data on ethnicity, gender, nationality and religion are rarely sought or analysed."
The ALI report urges all three services to take steps to reduce teenage suicides, which are 70 per cent more likely to occur in the Army than in civilian life.
ALI investigators visited 12 army establishments, four RAF bases, five naval schools and ships, three defence colleges, five defence agencies, four police academies, six army careers offices and three army, RAF and naval training agencies.