its the process of making the texture for each polygon by flattening a copy of each polygon to a 2d bitmap texture. ( not just bitmap the file format but a 2d pixel perfect texture)
basically you create a texture that represents each polygon on your model so you can paint onto it. Each polygon can possess one or more uv co ordinates that performs this procedure and finally re wraps back around the models surface.
You have to decide whats the best flattening method for each component. eg: a cylinder flattening method would be illsuited for a box but good for a cylindrical shape.
here is a sample of the texture i used for the dwarf.
You can assign raw colours to models but its not advised for speed purposes as it appears to have a slowdown, to acheive that you would affect the specularity and or diffision etc..
You can assign more than one texture to a model depending on your engines environment as well.
I highly reccomend www.unwrap3d.com, it makes it a breeze compared to a black art.
Another trick in milkshape once u get the hang of it is to screenshot areas onto a texture the exact same size as your current resolution this allows you to slowly make a perfect map instead of messing around with milkshapes fiddly texture co ordinate editor.
