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Making favicons with photoshop or one of those online utils can be a really slow process, and a lot of the time it is hard to tell before you start whether an image will work at 16x16 pixels.
Heres a quick way.
Make a fairly small version of the image. I made on at 50x50 pixels (it was originally gonna be an avatar). Host it on a page on its own. Then bookmark it and put it on the bookmarks toolbar in FF. Firefox makes a 16x16 version for you. Then do a screen grab and cut out the icon, and save as favicon.ico
[edited by: tedster at 4:48 pm (utc) on April 4, 2008]
I've been obsessing over favicons these days. So much so, that some of the sites I manage now have a library of favicons that apply to different sections of the site, http vs https, etc.
There are a plethora of online tools that allow you to generate favicons on the fly. And, you can even do animated image and text versions. :)