A much asked question. <img src="/ubbthreads/images/graemlins/smile.gif" alt="" />
It works differently from DD. No flasks needed and you can't use the mushrooms anymore.
Use the coloured 'bushes' you find in barrels etc and combine them by clicking in your inventory (might be right click, can't remember). It'll bring a menu up anyway.
Do a search here and you'll find some lists that tell you what each extra level of alchemy allows you to do, plus what all the combinations are. The basic one is blue + red makes health potion.