If turned on, iCloud will keep your contacts, calendars, notes, etc, on a server (similar to MS Exchange) allowing you to keep the content in sync with other devices (iPhone, iPad, iPod touch, Mac or even PC). Those are not part of the iCloud "backup".
You get 5 GB of free iCloud storage for:
- Photos and videos in the Camera Roll
- Device settings (for example: Phone Favorites, Wallpaper, and Mail, Contacts, Calendar accounts)
- App data
- Home screen and app organization
- Messages (iMessage, SMS, and MMS)
- Visual Voicemails
You can select which applications back up their data and see how much storage space each application is using:
- On your Home Screen, tap Settings
- Tap iCloud
- Tap Storage & Backup
- Tap Manage Storage
- Select the device you want to manage
Response to 2nd question: Selecting Delete on the iOS device would prompt you for removal from the Device only. Not from the cloud. Someone could theoretically delete your stored backup data, and manually delete your contacts / calendars etc.