Bone meal is created by putting a bone into a crafting slot. You will get 3 bone meal from one bone.
Bone meal can be used by shift-clicking wheat (still growing) to make it ready for harvest, red and brown mushrooms to make them giant mushrooms, and a sapling in dirt to make it a full grown tree. In addition, using bone meal on dirt will cause long grass, flowers and small mushrooms to grow for a few blocks around.
Bone meal is also used as a dye. It lightens the color.