blocking is a way of treating finished items to 'set' the stitches and final shape. It helps to even out tension across the whole piece and straighten out edges. It can be ddone in a number of ways, he simplest being to gently wash or soak in warm water, squeezy out any exess water and then lie flat on a specially made blocking board or somthing absorbent (i use a couple of bath towels) pinning the edges to the proper shape if necassary, and leaving to dry. other methods include lightly dampening a peice with a spray of water or steaming.
It isn't always necassary, especially for things
that get washed often or do not need to have a particular shape or fit (so a wash cloth as opposed to a sweater) but if you are gifting thing, it can realy make the difference in how they look and make any pattern knitted into them look that much better.
there are a few threads, particualrly in the 'watcch knitting' forums that show items before and after blocking and there is often a dramatic difference in how they look.
(examples of a lace scarf
the first couple of pictures are after and during blocking the 3rd picture is before blocking, see how it goes from being bunched up to all open and flat?)