Favicons are the custom images that are displayed in the location bar for websites that create them. They are also sometimes shown in your bookmarks/favorites.
So how do you create them? They are not simple BMP files, but almost. If you have a UNIX machine, you can create a favicon if you have the netpbm package installed. Here is the command to do it, assuming you already have a bmp file of the image you want (16 x 16 pixels):
bmptoppm favicon.bmp | ppmtowinicon > favicon.ico