A watershed is the area of land where all of the water that falls in it and drains off of it goes into the same place. Watersheds can be as small as a footprint or large enough to encompass all the land that drains water into rivers that drain into Chesapeake Bay, where it enters the Atlantic Ocean
The watershed consists of surface water--lakes, streams, reservoirs, and wetlands--and all the underlying ground water. Larger watersheds contain many smaller watersheds. It all depends on the outflow point; all of the land that drains water to the outflow point is the watershed for that outflow location. Watersheds are important because the streamflow and the water quality of a river are affected by factors, human-induced or not, happening in the land area "above" the river-outflow.