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Could someone help me understand when which kanji is used? For example I have seen 臭い on a packet of cat sand. I can't remember where I've seen the other but I found the following example sentence on jisho.org:
臭いをたどってみよう。
It's translated as "I should follow my nose."
At first I suspected that 臭い【におい】 is used for undesirable smell and 匂い【におい】 is used for good smell but the example above seems to contradict my little theory.
Yes you are right, 匂い and 香り is always for good smells like from flowers, food, etc, whereas 臭い is mostly for undesirable smells. But sometimes 臭い is neutral, which case I think your example falls into.
BTW that jisho.org page you cited seems to be a little confusing, because it lists [臭]{にお}い (noun) and [臭]{くさ}い (adjective) jumbled together. So, just be careful!
