What's the difference between restore from backup and restore to factory settings?

I have just updated my iPad 2 to os 5.1. I backed it up in iTunes before beginning the download. Do I use the restore button to get my apps and files back? The prompt says it will restore the device to the factory settings. I assume this means the previous os and I don't want that.

No, it does not mean the previous IOS.  It means the current IOS but everything else will be just as it left the factory.  Surprisingly, that same Restore is what you do if you want your apps and data files back:
Connect via cable to the computer that you use for sync.  From iTunes, select the iPad and then select the Summary tab.  Follow directions for Restore and be sure to say "yes" to the backup.  You will be warned that all data (apps, music, movies, etc.) will be erased but, as the Restore finishes, you will be asked if you wish the contents of the backup to be copied to the iPad/iPod.  Again, say "yes."

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    ============================================================
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