Towels are large pieces of cloth used to dry off one's hair and skin after swimming, bathing, or fighting for one's life against a sea monster. In lieu of clothing they can be wrapped around oneself to form a makeshift toga, although care must be taken that the towel is large enough, positioned correctly, and stabilized. It's usually easier to just wear clothing.
A towel is also just about the most massively useful thing an interstellar hitchhiker can have. Partly it has great practical value. You can wrap it around you for warmth as you bound across the cold moons of Jaglan Beta, you can lie on it on the brilliant marble-sanded beaches of Santraginus V, inhaling the heady sea vapors; you can sleep under it beneath the stars which shine so redly on the desert world of Kakrafoon, use it to sail a miniraft down the slow heavy River Moth, wet it for use in hand-to-hand combat, wrap it around your head to ward off noxious fumes or avoid the gaze of the Ravenous Bugblatter Beast of Traal, you can wave your towel in emergencies as a distress signal, and of course dry yourself off with it if it still seems to be clean enough. Some, like Roosta’s, can be sucked on for nourishment; the yellow stripes are high in protein, the green ones have vitamin B and C complexes, the little pink flowers contain wheatgerm extract. The Bar-B-Q stains are for when he gets sick of rations, and one corner has antidepressants.
More importantly, a towel has immense psychological value. For some reason, if a strag (nonhitchhiker) discovers that a hitchhiker has his towel with him, he/she/it/etc. will automatically assume that he is also in possession of a toothbrush, washcloth, soap, tin of biscuits, flask, compass, map, ball of string, gnat spray, wet-weather gear, space suit, etc, etc. Furthermore, the strag will then happily lend the hitchhiker any of these or a dozen other items that the hitchhiker might have accidentally “lost.” What the strag will think is that any man who can hitch the length and breadth of the universe, rough it, slum it, struggle against terrible odds, win through and still know where his towel is, is clearly a man to be reckoned with. Hence a phrase that has passed into hitchhiking slang: “Hey, you sass that hoopy Ford Prefect? There’s a frood who really knows where his towel is.”
One sapient talking towel with the power to generate a small atmosphere around itself and fly through space is known to exist. It is named T'owel, and so it is suspected that creativity is not its strong point.