From Joomla! Documentation
Every part of Joomla! powered web site or any CMS type of web site needs a method to display and store its content logically. The usual method is by categories and subcategories. Joomla! allows for multiple ways to display and use content controlled by categorisation. Some of the content types which have categorisation are articles (Main content of web pages), banners, contacts and web links.
Joomla! category named "Uncategorised" is the default category, assigned to any and all content types. The "Uncategorised" category is not descriptive and should be used on as needed basis for content types which do not fall under a specific category.
When creating and assigning categories, you should have a planned structure. As an example, this is one way of how you would categorise several Joomla articles on birds. Create two top article categories called "Animals" and "Plants". Under the "Animals" category, you might have sub categories called "Birds" and "Mammals". Under the "Birds" sub category, you might have 3 articles named "Hawks," "Parrots" and "Sparrows".
The example above could be expanded even more with specific articles on different species of Hawks, Parrots and Sparrows. Start with using an "Animal" top Category, placing the sub categories "Birds" and "Mammals" are under the "Animal" category, and then a "Hawks," "Parrots" and "Sparrows" sub category under the "Birds" Sub Category as shown below.
Now you can create multiple articles in the Hawk, Parrot and Sparrow sub categories using the different genus or common names of the specific types of these 3 birds.
Categories and their sub categories are maintained using the "Category Manager" which can be reached in the administrator back-end interface by clicking on the "Content" menu type, then the "Category Manager" menu item for the type.