What does a sanity check involve?

A sanity check involves verifying assumptions against reasonable benchmarks to ensure that they are logical and feasible. This process is critical in various fields, including finance, engineering, and data analysis, as it helps identify any errors or unrealistic expectations in the initial assumptions before proceeding further with a project, analysis, or decision-making process.

Conducting a sanity check ensures that the parameters being used fit within a credible range, which adds credibility to the results and helps highlight any potential issues early on. This practice serves as a safeguard against overlooking significant errors that could lead to poor outcomes if left unaddressed.

Other options, such as verifying financial losses or assessing cash flow timings, while valuable in their own right, do not specifically pertain to the broader and foundational concept of sanity checks, which focuses primarily on evaluating assumptions. Similarly, estimating future market performance can be a complex process but isn’t inherently part of the sanity check concept, which is rooted in assessing the validity of the inputs rather than forecasting future conditions.