A system image is basically a snapshot of your entire hard drive. It includes the operating system, all of your personal settings, documents, folders, videos, music, photos, pretty much everything. If you have a problem with your computer (a virus, a program you installed crashes everything, etc) you can restore your computer back to that system image and your computer will be exactly as it was when the image was created. If the image is a week old, that's how your computer will be and you'd have to update your antivirus, Windows Updates, etc.
In most cases, you'd want to store your system image on an external hard drive. If you ever needed to replace your computer's internal hard drive, you'd be able to use that system image on the new (replacement) hard drive. And instead of spending hours, or even days, trying to reconfigure everything the way it was, a system image can get you up and running in about 30 minutes or less.
How to Create a System Image in Windows 7 - How-To Geek
If you use the built in Windows 7 imaging tool you'll also be given an opportunity to create a separate companion repair disc. If your computer won't even boot to the operating system you can use the repair disc to access various repair options as well as restoring to the system image.