Definition: An ISO file, often called an ISO image, is a single file, perfect representation of an entire CD, DVD, or BD. The entire contents of a disc can be precisely duplicated in a single ISO file.
You can think of an ISO file like a box that holds all the parts to something that needs built - like a child's toy you might buy that requires assembly. The box that the toy pieces come in does you no good as an actual toy but the contents inside of it, once taken out and put together, become what you're actually wanting to use.
An ISO file is the same way. The file itself is no good unless it can be opened, assembled, and used. The most common way to make use of an ISO file is to burn the ISO file to a CD, DVD, or BD disc. It's a different process than burning a bunch of music or document files to a disc because your CD/DVD/BD burning software must "assemble" the contents of the ISO file onto the disc.
ISO image files are often used to distribute large programs over the Internet due to the fact that all of the program's files can be neatly contained as a single file - the ISO file.
There are several programs, many of them free, that you can use to create your own ISO file from a disc. See How To Create an ISO Image File From a CD, DVD, or BD for help doing that.
ISO images end in the file extension ISO. For example, the free Ophcrack password recovery tool (which contains an entire operating system and several pieces of software) is downloaded as the ophcrack-vista-livecd-3.4.0.iso file.
If you don't want to actually burn an ISO file to a disc, most compression/decompression software programs, like the free 7-Zip or PeaZip programs, will extract the contents of an ISO file to a folder.
Also Known As: ISO image
Examples: "I downloaded an ISO file from a torrent site (it was legal, don't worry) and tried to burn it to a DVD but it wouldn't do anything after that. I finally realized that I had to 'burn the image' with my burning software, not just stick the file on the CD."