As in many games, characters in LF2 have health and mana. Both regenerate slowly (health to a more limited extent), and both can be replenished. Normally, being at full health means that one has 500 health and 500 mana. readme.txt divides all mana values by 5.
Whenever a fighter gets hurt, two thirds of the damage (rounded up, and calculated after damage reduction due to defending) is kept as "potential" health (with the exception of Firen exploding, where all of the health he spends to explode is kept as potential health). Potential health is the dark-red segment of the health bar. It continually converts to regular health at the rate of 1 point every 12 frames.
It is worth knowing if someone has no bright red pixels visible in their health bar, it means they have less than 5 health.
John, Sorcerer and Jan have special moves that speed up health regeneration. To be precise, they add an additional 8 health every 8 frames on top of the normal 1 point every 12 frames. The effect runs out after it restores 104 health, or when there is no more potential health. These healing effects do not stack: if a character is healed while a previous heal is still in effect, the previous heal will be renewed, not added to.
Drinking milk gives 80 potential health at the rate of 4 every 5 frames, and 160 actual health at the rate of 8 every 5 frames, with actual always capped by potential. (In truth, milk restores health 2 frames after starting drinking, then some health after 1 frame, then after 2 frames, and so on, but it is not too much of a simpification to say that it restores some health once every 5 frames.) It also gives 166 mana at the rate of 5 mana every 3 frames. Beer restores 750 mana at the rate of 6 per frame.