One of the things some dyslexic children have difficulty with is playing with the words in sounds.
Phonological awareness is the umbrella term for playing with words and parts of words, for example, rhyming words like cat, fat, bat, sat, etc. It involves being able to separate sentences into words, words into syllables, and syllables into their individual sounds.
Phonemic awareness is the ability to hear and manipulate those individual sounds in syllables and words. For example, being able to hear the first sound in the word hat as /h/. It is an understanding that words are made up of individual sounds and the ability to manipulate those sounds.
Why is this important? A child who can manipulate the sounds in a word can easily read the word bat, if she can also read the word hat. Her brain can make those substitutions easily and form the new word by drawing upon what she already knows.
The typical progression for phonemic awareness is that children are able to pick out the first sound in a word first, then the final sound, and lastly the medial or middle sound. Conversely, when children begin writing, their very early writing will be a string of consonants that may include only the first sound in the word, and then progress to the first and last sounds in some words. Hopefully I'll have some samples of children's work to show you as the year progresses.
One of the games we play in a Montessori environment is called "I Spy" and it's purpose is phonemic awareness. We have a basket of objects that we lay out on the table or rug and we name them as we lay them out. Initially we'll start with 2 or 3 objects only. There might be a hat, a ball, and a mouse. Then we'll say, "I spy with my little eye, something that starts with the sound /m/." It would be the child's work to pick the mouse.
I'm often told by parents that their child "knows all of the letters" and indeed that child does. But, what that child is lacking typically is the abilitiy to play with the sounds associated with the letters or even to know the sounds associated with those letters. If we can start children when they're young and help them get some solid phonemic and phonolgical awareness skills, we'll be helping them become much better readers in the long run.