Categories are used to group tools by type, and there is only one by default, "Uncategorized". For example, you might have a category called "Cordless Drills" and another called "Ladders". This helps with reporting and filtering. Be as specific as you like, although keep in mind, each tool can only possess one category.
Categories use the "Name" field, although have a prefix value as well. This is for the ToolId field on the tool. If a tool has an ID with an category prefix, it will automatically be assigned to that category. If the category is changed, but the prefix is not updated, it will revert to the category that matches the prefix.