Armed opposition groups have retaken control of large areas of the Horn of Africa nation, launching near daily attacks on the transitional government forces and their Ethiopian allies.
The report said breaches in the embargo are being financed from sources
"including the government of Eritrea, private donors in the Arab and Islamic world and organised fund-raising activities among Somali diaspora groups".
Ethiopia and Eritrea, which have been accused of fighting a proxy-war in Somalia, have been in dispute over their shared border since a bloody conflict ended in 2000.
The report said that criminal gangs, including pirates operating off the coast, were adding to the lawlessness in the country and are "typically self-financing, employing the proceeds from piracy and kidnapping to procure arms, ammunition and equipment".
"Some of these groups now rival or surpass established Somali authorities in terms of their military capabilities and resource bases," it said.
Earlier this week, the UN Security Council passed a resolution authorising the use of land operations against Somali pirates, who have captured dozens of ships and held hundreds of crew members for ransom over the past year.
The Security Council on Friday voted for the mandate of the monitoring group, which recommends groups and individuals who should be blacklisted for their role in the arms trade, to be extended for another year.
Somalia's transitional government, which is based in the central town of Baidoa because of the security situation in the capital Mogadishu, has effective control over only a small part of the country.
Somalia has had no effective government since a coup removed Siad Barre from power in 1991, leading to an almost total breakdown in law and order.