I am currently trying to make a very basic rescue disk for my linux box. All i require is the basic lilo config and the Kernel.

I have tried

mkbootdisk --device /dev/fd0 2.4.2-2

and it tells me all my loopback devices are being used??

I tried

dd if=/boot/bzImage.lance10 of=/dev/fd0 bs=1k

where bzImage.lance10 is my current kernel config i use in lilo.

This does not seem to work . When i reboot the system runs out of input information??

Any ideas before i try to make a compressed lilo/kernel/root system on 2 floppies!!

Your dd command is the right one. But after the kernel is written there is something to do.
rdev /dev/floppy /dev/floppy
if you'd like it to have its root on floppy or something similar in other cases.
You may also refer to Bootdisk-HOWTO (valuable info).