It works essentially like this:

Say I want to make a copy of my Diablo 2 Expansion CD. I can make an image file of the entire CD. That would be the ISO file.

If I were to take that image file and burn it to a CD, that CD would, essentially, be a copy of my Diablo 2 Expansion CD.

Just the same, if I were to send that file to someone else over the internet, they could use it to burn a copy of the Diablo 2 Expansion CD as well.