I do not know why OE decided to re-arrange your folders, but it was very sensible of it.
Maybe OE had decided 'enough is enough - I'll do it if he/she won't' and did it during one of its compacting 'tidy-up' sessions.
<<Also, 'Inbox' has always been at the top of the list, under 'Local Folders', but 'Outbox, Sent Items, Deleted Items & Drafts' were all at the bottom, beneath my list of created folders. These have now all moved up to the top, beneath 'Inbox'.>>
That is how it is supposed to look as the above are all 'system folders' of OE
The Inbox should not have any sub folders (yes, I know you can create them, but it gets very shakey/flakey and may crash OE eventually) (a design fault? maybe, but that is how it is)
Any folders you do create should be a sub-folder of (linked to) Local Folders
When you say ""'Friends' folder, for example, and all the friends' individual names, are now in a single line alphabetically under 'Local Folders', so I have to trawl through the whole list to find individual friends""
do you mean the individual named folders are not now inside the Friends folder?
If so, then just drag them back inside the Friends folder.
The path should be: Local Folders > Friends > and then a list of folders with individual names
Note: OE compacts and tidies up after every 100 times the program is used. It is supposed to do this - just let it that's the way it's been designed and don't use any other programs until it has finished or your email may get corrupted/lost - can't do anything to alter that.