This is one of those great kill-two-birds-with-one-stone projects. Got lots of old towels kicking around that are too ratty to donate but you don't want to dump them in the landfill? Got a child (or better yet, children) with busy little fingers? Have we got the perfect rainy day activity for you.
We spotted this fabulous little how-to on Ecologue by way of Cookie's Nesting blog a few months back, and we bookmarked it in anticipation of Kitchens and Bathrooms Month. All you need is a bunch of old towels (old t-shirts will also do) and gridded matting that you should be able to find at most craft stores.
The instructions are pretty straightforward. Read them in their entirety -- and watch a helpful video -- at Ecologue.

White Enamel Flatwa...
how cute! great idea!
I like this idea - I was already toying with the idea of cutting up old bathtowels with frayed edges into 12" squares and making my own washcloths...
Old terry cloth bath towels would make a terrible mess if done this way. Old tee shirts---that would work nicely. But I save old bath and kitchen linens, and old tee shirts for disasters, and cleaning, painting, car-washing, et cetera.
Sunny is right - I sew a lot, and cutting terrycloth is the most god-awful mess ever. It gets on everything, and doesn't stop - the cut terry sheds bits for weeks after cutting!
You'd need to do this in a small area, to keep the mess contained, then wash it a few times to clear all the shedding terry before use.
But it looks great!
This reminds me of those old latch hook yarn pictures and things that you did as a kid. I wonder if you could use the latch hook for this project or would the fabric be too thick?
I could see doing it with old tee shirts- but terry cloth? Only if I want to kill my dryer!
Hmmm... I might have to save this project yet ;)
just a note that another great way for keeping old ratty towels (and blankets) out of the landfill is to donate them to your vet or animal shelter for bedding.