I wish to restore my computer to factory setting, in order to do that I want to backup the system to an external drive (which has data on it. At some point I'm prompted to choose "make backup bootable" if I tick this box I receive a warning that all the data in the external drive will be deleted ?
Why is that ? do I have to backup the system to a clean external drive ?
The system needs to make the external drive bootable for the recovery - yes, you will lose everything on the drive when you do this.
There are other ways to do this that don't require wiping the external drive but WILL require you make boot media on CD/DVD or a flash drive - Macrium Reflect, Easus Todo, etc.