Crazy Eddie

 Crazy Eddie's Financial Analysis

Crazy Eddie was a consumer electronics supermarket that dominated the retail consumer electronics market in the metropolitan area.  Crazy Eddie was considered as the next big thing and a great investment.  However, overnight Crazy Eddie went from being worth millions to bankruptcy.  Crazy Eddie’s management team became experts at “cooking the books” and playing the system.  For years they had everyone fooled until their many fraudulent practices became exposed.

*** To view Crazy Eddie’s financial statements the reader can visit: http://business2.fiu.edu/1048733/www/Spring_2011_ACG6686_RXN/Crazy%20Eddie.pdf

Crazy Eddie’s balance sheets from 1984 to 1987 had many red flags: 

• First, between 1986 and 1987 the balance sheet shows receivables increased by a substantial amount.  During 1984, 1985, and 1986 receivables were roughly around the mid to high $2,000,000’s.  However, from 1986 to 1987 receivables jumped almost $9,000,000, which is a 21% increase.  This alarming increase is definitely something that should be looked into. Overstating their receivables, Crazy Eddie not only affecting the balance sheet, it also affects income and equity. 

• Crazy Eddie manipulated the current liability section.  From 1984 to 1987 the percentage of current liabilities to the total of liabilities and stockholders’ equity decreased making it seem as if they are concealing their current liabilities into long-term debt. 

• The inventory account was also manipulated.  In 1984 and 1985 inventories were reasonable.  However, in 1986 inventories doubled and then in 1987 inventory doubled again.  Overstating the inventory account causes the cost of goods sold on the income statement to be understated and will cause the net income to be overstated.

• Crazy Eddie focused all its money on the receivables account and inventory account.  By doing this they were not generating any cash flows, which would make it difficult for them to pay their liabilities.

The common size income statement shows the inventory account on the balance sheet was overstated. This will cause the cost of goods sold on the income statement to be reduced by the same amount.  Since the income statement calculates gross profit by subtracting the cost of goods sold from the revenues earned, the overstated ending inventory will result in an overstated gross profit on Crazy Eddie’s income statement.  Crazy Eddie deliberately manipulated their inventory in order to attract investors.   Also, from 1985 to 1986 revenue increased by almost $100,000,000 and then increased again by $100,000,000 from 1986 to 1987. One can assume by this rapid increase, Crazy Eddie was overstating their revenue.  If revenue is overstated, their net income will also be overstated.  This overstatement will make Crazy Eddie look more profitable, which will attract more investors.

Using ratios to analyze Crazy Eddie’s financial statements will show how these manipulations will affect other areas on the financial statements:

• Crazy Eddie’s profit margin decreased from 1984 to 1987 due to the overstatement in revenue, which caused net income to also be overstated. 

• Crazy Eddie’s inventory turnover continually decreased from 1984 to 1987.  This decrease is an indicator that Crazy Eddie was manipulating their inventory account because since revenue was increasing, inventory turnover should increase as well. 

• Crazy Eddie’s quick ratio increased throughout the four years.  However, considering current assets are needed when calculating the quick ratio, the ratio might be unreliable since receivables were possibly manipulated.

• Crazy Eddie’s age of payable ratio increases from 1984 to 1986.  In 1984, the average amount of days to make payment was 67, which then increased to 97 days by 1986.  This is a significant amount of time for a company to take to pay back their bills.  Then, in 1987 the average days dropped from 97 days to 67 days.  This substantial decrease in only a year for a company to pay back their bills is quite alarming and causes for great speculation.  This significant decrease makes it seem like Crazy Eddie was manipulating another account in order to pay back their liabilities quicker.

• Crazy Eddie seemed to manipulate their current liability section since the percentage of current liabilities to the total liabilities and stockholders’ equity decreased.  By concealing their liabilities into long-term debt, Crazy Eddie’s current ratio will be manipulated.

I strongly believe the auditors should have detected the fraud sooner.  There were various red flags in Crazy Eddie’s financials, which should have raised concerns amongst the auditing team.  After analyzing Crazy Eddie’s balance sheet, income statement, and ratios many questions came to mind:

1.        1.  Why was Crazy Eddy’s inventory turnover rate decreasing over the four years when they were     profitable?

2.        2.  Why did Crazy Eddie overstate its receivables in 1987?

3.        3.  Why did revenue increase by so much in 1986 and 1987?

4.        4.  Why was Crazy Eddie able to pay back their liabilities quicker in 1987?

5.         5.   Why did Crazy Eddie manipulate their current liability section by putting their current liabilities into long-term debt?

    6. How was Crazy Eddie able to pay their liabilities, it they were focusing all their money on the inventory and receivable accounts?