Generally, an exercise can be categorized by the muscle or groups of muscles that are worked. For example, a dumbbell curl targets your biceps and the pec dec fly targets your chest muscles. Exercises can also be categorized in terms of the motion of your muscles when performing that exercise, i.e., as either an isolation or compound type exercise.
An isolation exercise targets the movement of your muscles around only one joint, allowing you to concentrate your effort in working one particular muscle group. Some common isolation exercises include dumbbell flies, leg extensions, leg curls, lateral raises, calf raises and wrist curls. Conversely, a compound exercise requires movement around more than one joint, often working multiple muscle groups when performed. Common compound exercises include squats, deadlifts, barbell rows, chin-ups, dips, bench presses and military presses.
So why categorize exercises as isolation type or compound type if these exercises can already be categorized by the muscles worked?
One benefit deals with the efficiency and effectiveness of a workout. It is probably obvious that you have the most energy when performing the first set of a workout session and as you execute more and more sets, this energy reserve becomes more and more depleted. The exercises you perform towards the end of a workout become less and less effective as your form deteriorates and the speed at which you perform the reps increases (for example, you start to "drop" the weights instead of controlling them during descent).
To counter this ineffectiveness, for each muscle group that I workout during a session, I try to organize the exercises such that the isolation type exercises are performed during the start of the session and the compound type exercises are performed during the end of the session. The logic behind this is determined by the definition of a compound exercise itself. A compound exercise utilizes more than one muscle group to perform a set, decreasing the amount of work each muscle has to exert. Simply, I use the unused, "fresh" muscles in a compound exercise to help work the target muscle even further.
For example, consider my chest workout. During this session, I structure the exercises such that sets of the pec dec fly (an isolation exercise) are performed before sets of the decline press (a compound exercise). My triceps are used in the decline press to help push my chest muscles further into exhaustion.