Under orders to try and make more money, the makers of the movie released the PG-13 theatrical version. It cut a lot of the gore and blood out, making the battles rather choppy, as you see guys swinging swords and it cuts to people just falling down dead. The theatrical release also has some bad jokes about bladder problems and stuff, like the movie is trying to appeal to immature viewers, or something.
The director's cut restores the violence, making the battle scenes much bloody and smoother, and the joking scenes are replaced by much more serious ones showing more character development, giving Arthur and Lancelot more depth. All in all, the director's cut is better; it makes the climax of the movie, and Arthur and Lancelot's final decisions, much more understandable and moving.