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Squid stores some of its recently retrieved objects fully in memory. As you might expect, serving objects from memory is generally faster than reading the data from the disk. In some places, Squid calls this the hot object cache. The cache_mem directive specifies how much memory Squid should use for in-memory objects.
I usually recommend setting cache_mem to a small size, such as something between 8 and 32 MB. If you happen to have tons of extra memory, you can set it higher. In most cases, however, your extra memory is better used by increasing your disk cache size (see Section 7.1.3.2).