In this chapter, costs and revenues and basic accounts are used to show how firms actually operate in construction. For example, instead of general profit maximizing behaviour from standard economic theory, construction firms often focus on short-term cost reduction in order to complete projects profitably. In order to survive, firms need to ensure not only that they are profitable but also that they can anticipate their cash flow requirements. An important priority for the managers of any firm, and especially in construction, is therefore the management of cash flow and working capital.

In construction, marginal costs include the additional cost of utilizing the fixed capital assets needed to produce the extra unit of output as well as marginal prime costs. The marginal prime costs are the direct costs of supplying the extra work needed to produce the extra unit of output and may include labour, materials and the hiring of tools and plant. In any case, a building firm has little or no control over how much to produce and cannot change that quantity to suits its own purposes. This is because, in construction, output is concerned with projects, many of which are very large and entail the hiring or purchase of equipment that may go on to other projects after the current project ends. For example, construction product manufacturers, such as firms that supply domestic boilers, can use marginal cost pricing – that is, pricing based on the marginal cost – to determine the level of output for pricing their output. However, it is unusual for contractors to use this method, not least because it is extremely difficult to calculate in practice in the construction industry. Instead, contractors use mark-ups or full cost pricing to determine the tender prices they submit to clients.

Although this theoretical economic approach, called marginal cost pricing, explains the derivation of the profit-maximizing level of output, it does not determine the quantity to produce as far as construction contractors are concerned. Contractors rarely have the luxury of choosing the quantity they produce, apart from deciding whether or not to bid for projects as and when they come to the market.