iCloud Storage Baffles me! Contradictory!

I am completely baffled as to how iCloud works.

Yesterday my wife upgraded to a shiny new 16gb iPhone 6.

After set up a message appeared on screen stating that she was nearly out of storage space.

(She pays Apple £0.79 per month for 20gb.)

On the other hand, when I went to Settings>iCloud>Storage it showed 17.2gb available!

How can there be this contradiction? I am baffled. How on earth does iCloud storage work?