I start with a fresh tree from trunk and follow the instructions here http://wiki.openwrt.org/doc/devel/patches

i do

make target/linux/{clean,prepare} V=99 QUILT=1

the menuconfig opens.

i select bcm63xx for target system and save, kernel extracts, patches apply but then:

Now at patch platform/440-new_96348gw-11_leds.patch
touch "/home/ant/openwrt/trunk/build_dir/linux-brcm63xx/linux-2.6.35.9/.quilt_checked"
/home/ant/openwrt/trunk/scripts/kconfig.pl + /home/ant/openwrt/trunk/target/linux/generic/config-2.6.35 /home/ant/openwrt/trunk/target/linux/brcm63xx/config-2.6.35 > /home/ant/openwrt/trunk/build_dir/linux-brcm63xx/linux-2.6.35.9/.config.target
awk '/^(#[[:space:]]+)?CONFIG_KERNEL/{sub("CONFIG_KERNEL_","CONFIG_");print}' /home/ant/openwrt/trunk/.config >> /home/ant/openwrt/trunk/build_dir/linux-brcm63xx/linux-2.6.35.9/.config.target
echo "# CONFIG_KALLSYMS_EXTRA_PASS is not set" >> /home/ant/openwrt/trunk/build_dir/linux-brcm63xx/linux-2.6.35.9/.config.target
echo "# CONFIG_KALLSYMS_ALL is not set" >> /home/ant/openwrt/trunk/build_dir/linux-brcm63xx/linux-2.6.35.9/.config.target
echo "# CONFIG_KPROBES is not set" >> /home/ant/openwrt/trunk/build_dir/linux-brcm63xx/linux-2.6.35.9/.config.target
/home/ant/openwrt/trunk/staging_dir/host/bin/sed -i -e 's,.*CONFIG_AEABI.*,# CONFIG_AEABI is not set,' /home/ant/openwrt/trunk/build_dir/linux-brcm63xx/linux-2.6.35.9/.config.target
bash: /home/ant/openwrt/trunk/staging_dir/host/bin/sed: No such file or directory
make[3]: *** [/home/ant/openwrt/trunk/build_dir/linux-brcm63xx/linux-2.6.35.9/.configured] Error 127
make[3]: Leaving directory `/home/ant/openwrt/trunk/target/linux/brcm63xx'
make[2]: *** [prepare] Error 2
make[2]: Leaving directory `/home/ant/openwrt/trunk/target/linux'
make[1]: *** [target/linux/prepare] Error 2
make[1]: Leaving directory `/home/ant/openwrt/trunk'
make: *** [target/linux/prepare] Error 2

/home/ant/openwrt/trunk/staging_dir/host/bin/sed is missing. I assume it has to be built or can i link it to my systems sed?  Is this a bug or am i not doing it right?
I have used quilt to make an openwrt patch before only difference is that i was experimenting, basically build test modify so i never tried to start from a proper clean tree.

Are you attempting to build a new kernel patch ?
this is mywork flow.

1. I build normal openwrt image for vmware.
2. then I go to build_dir look there for kernel folder.
3. I open it in understand (its one reverse engineering tool I like) its commercial but trial license too should work fine. There are couple more of tools I use..
4. I edit code directly the the build dir tree.............. recompile without doing make clean
5. advantage is.. patches are applies only when the package is extracted from kernel source  so.. i can get some speed bum while simulation full compile without actually doing one.
6. I take this image and run it on vmware box...... test everything I feel I should,,
7. when am satisfied  I extract  a new copy of fresh kernel and diff it with modified code.
8. now I  have a patch set which I can place in appropriate target directories.

hope whatever I said was helpful.

What i did was basically the way that the documentation says to do it but, what you said

1. I build normal openwrt image for vmware.

Build an image first -> modify code -> make patch -> rebuild. Difference is its for a bcm6348 but thats the only way i can get it to work.