Human auditory perception is limited in range and varies between individuals. Each person hears sound slightly different. Certain range of frequencies cannot be heard by humans. Just like ultraviolet or infrared frequencies are imperceptible to human eye. This observation led to the development of lossy compression algorithms.
Lossy compression means that the signal data is more or less reduced such that the output file is smaller in size. Lossy compression thus results in irrecoverable data loss. However, quality loss is small compared to reduced file size.
Lossless compression (which is used by FLAC format) is a type of compression that produces smaller files but with no losses in audio data (and thus signal quality).
It is worth mentioning that only a small part of the signal is lost due to signal quantization.