Drought continues to be a major constraint on cereal production in many areas, and the frequency of drought is likely to increase in most arid and semi-arid regions under future climate change scenarios. Considerable research and breeding efforts have been devoted to investigating crop responses to drought at various levels and producing drought-resistant genotypes. Plant physiology has provided new insights to yield improvement in drought-prone environments. Crop performance could be improved through increases in water use, water-use efficiency (WUE) and harvest index. Greater WUE can be achieved by coordination between photosynthesis and transpiration. Carbon isotope discrimination (Δ13C) has been demonstrated to be a simple but reliable measure of WUE, and negative correlation between them has been used to indirectly estimate WUE under selected environments. New tools, such as quantitative trait loci (QTL) mapping and gene expression profiling, are playing vital roles in dissecting drought resistance-related traits. The combination of gene expression and association mapping could help identify candidate genes underlying the QTL of interest and complement map-based cloning and marker-assisted selection. Eventually, improved cultivars can be produced through genetic engineering. Future efficient and effective breeding progress in cereals under targeted drought environments will come from the integrated knowledge of physiology and genomics.