Toast is required to be made during the tutorial of Stage 3. After Harvey teleports the doctor to the "danger kitchen" on the Jim Dandy, he tells the doctor to pick up the toaster and loaf of bread, and then tells the doctor to comboine them. Doing so creates toast, which can then be picked up. After he eats the toast, the doctor remarks it is delicious. Harvey then explains this is how he will combine items, and how he will use items.
Toast does not do anything beneficial for the player.
The player can hold a total of 10 pieces of toast. No matter where they land, they can be picked up and used (floor, metal, under water, urinal, etc). When eaten, 1 toast is consumed from the player's inventory, and can be replaced. If the player has 10 pieces of toast, they cannot pick up any more toast.
Once the player receives the Atomic Toaster, they can no longer make regular toast. Therefore, if the player would want toast in their inventory, they must do so before using the Leaf Blower to save Kermit from the Bottrocks.