Hi,

On the add/edit product page, Zen-cart uploads the product image to the images/ folder by default. It's ok to put it there, but if you wish, you can create different folders subordinate to images/, based on manufacturer, product type, etc. For instance images/vases and images/mugs.
At that stage don't bother about small, medium and large, just make sure that the uploaded image is large enough to create the 'large' image from.

Later on, you use IM to create medium and large size images from the one uploaded. IM wil automatically place the medium/large size images in the appropriate folders and apply the suffixes (usually _MED and _LRG) to the files. If any folder doesn't exist yet, IM will try to create it for you.
Your last action in IM is to reduce the size of the originally uploaded image to small, according to the size defined in the config settings.

Does this answer your question?