What is a squib and how do I build one?
Internet Filmmakers' FAQ
A squib is a small explosive charge, connected to a soft packet of fake blood. When a squib is set off, it creates the effect of an actor being hit by a bullet. Squibs come in different sizes for different levels of effect, and also vary in how much discomfort they cause the actor wearing them. Purchasing squibs normally requires a relevant explosive-handling qualification/license.
In terms of building your own squibs, this is not recommended. At risk of sounding overly parental, squibs are not something you should be knocking up in your garden shed. Backyard solutions involving explosives are the easiest way for an actor to lose a finger or your sound guy to lose an eye. Do yourself and your crew a favour and a) buy some properly manufactured squibs, and b) employ a qualified professional to handle them. No budget is too small to jeopardise your cast and crew's safety.
If your action movie just absolutely, positively must have blood, then check out a safe alternative to using squibs, described in (gory) detail over at Exposure.co.uk. You should also check out the alt.movies.visual-effects FAQ and visit the Visual Effects Society.
More information on on-set safety can also be found at the web site of Australian armour John Fox.