How does .htaccess file work?

That's a wildly extensive topic.  Almost any piece of Apache configuration (there are certainly some exceptions) can go in a .htaccess file.  Google will find hundreds of decent tutorials on using them (the first result for ".htaccess" is here: http://www.javascriptkit.com/howto/htaccess.shtml )

Can you be a little more specific about what you want to know?

One of the most common uses of .htaccess is to hold directives associated with the mod_rewrite module.
As VoteyDisciple points out, this is one of many "complex" topics.

For mod_rewrite, .htaccess is used to contain directives that are specific to the containing directory.

mod_rewrite is frequently used to simplify URI's (i.e., the portion of the URL after the hostname (and optional port number)).

For example, using mod_rewrite, a URL like:

http://hostname/mod/rewrite/tutorial/

can be transformed to the URL required by the back end:

http://hostname/some_file.php?name=mod_rewrite_tutorial