"A discarded piece of cloth (100% cotton)." - Jagged Alliance
Jagged Alliance and Deadly Games
They can most often be found in bathrooms set on shelves or in set in cabinets, as well as in lab areas, scattered on worktables.
Jagged Alliance v1.13
The 1.13 mod adds rags to the list of mergable junk items that can be picked up, allowing you to use them in combination with a Bottle of Alcohol to fashion a Molotov Cocktail.
Applying the rag to a Bloody Throwing Knife will clean it.
They can also be used to remove an application of camoflage from a merc, by clicking on the merc's bronze statuette while a rag is in hand.
Rags can be easily obtained by combining a T-Shirt and any type of Knife, which will destroy the shirt and replace it with a rag. Note that the knife must be applied to the t-shirt for this to happen, not vice versa.