Okay quick and easy.
Once you have a basic setup that you'd like to see in the arena for testing go to Select then All. Then go to Edit, copy merged or hit shft contrl c. Then click on File and then New. Ensure the size of the new file is correct (1024x1024) and hit okay.
This will put up a blank 1024x1024 image (preferrably transparent). Then hit Edit, then paste or cntrl v. That should put your skin inside the new image area. Once you've done that go to Image, Mode, and then indexed color. It will pop up another window. It should already be setup correctly so just hit okay. Now go to File then save as. Save your file as a .bmp. Ensure the name is exactly like what your saved skin name was and your done.
Now if you want to adjust stuff again. Follow the same steps but select your original .bmp image. Click on Image, Mode then RGB color. Once you've done that click cntrl v to paste your new image into that file. Then go back to Image, Mode and indexed color. Follow the same procedure as before to save it and then go check it out.
One thing to note always ensure you've got the right image selected when you paste. If not you'll accidentally drop that copied image into the wrong spot. If so just hit cntrl alt z to undo the last command. And reselect the right image and paste it in there.
Hope this helps.