Unsurprisingly, Facebook makes most of their money off of advertising. Facebook ads brought in $300 million in revenue in 2008, $500 million in 2009, and ad revenue is expected to reach $800 million in 2010.
Facebook offers two types of advertisements: self-service ads and engagement ads. The first type are fairly simple: they consist of a title, picture, and a bit of text, and the user can click the link or "like" the advertisement. Engagement ads are more complex; they allow for things like surveys that let the user interact with the advertisement.
In 2009, Facebook brought in between $250 and $300 million from self-service ads and $100 million from endorsement ads.
Facebook also displays a large number of Microsoft ads (due to a 2007 ad deal); as of 2009, that spending had reached $50 million.
Because Facebook knows a lot about its users, it's able to allow users to precisely target those who are most likely to click on the ads, which allows them to offer a fairly low cost per click. Aside from making the advertisers happy, this also improves the user experience because users are more likely to see advertisements that actually interest them. For example, a user may list a particular band as being one of his interests. When that band has a new CD out, they may opt to have the advertisement to that CD shown only to people who have identified them as an interest.
Because Facebook has so many users (more than five hundred million active users, at last count, with half of them logging in on any given day), they can show billions of ads every day.
Facebook's self-serve targeting (advertisers set up everything themselves using a simple web form; Facebook employees merely approve the ad text) means new advertisements can start running almost immediately with minimal effort, keeping costs down for both Facebook and their advertisers.