When initially setting SharePoint up, there is an option to allow for the creation of users on the Active Directory using SharePoint. However, if you do not select this method during the installation, you will not be able to change your mind at a later point.

Okay, we are in the testing and evaluating the products, so we can re-install sharepoint portal server or services, but after selecting Active Directory Account Creation Mode for WSS, would we be able to add users directory from the web interface of sharepoint or do we have to add user first into active directory and then we have to select that users from web interface, b/c if user does not exist into active directory sharepoint interface does not add that user and give error message.

What I read from Microsoft site for User Account Mode:
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User Account Mode

When you install Windows SharePoint Services, you must choose which mode you want to use to allow users access to Windows SharePoint Services sites. Windows SharePoint Services can work with two modes: domain account mode and Active Directory account creation mode. Domain account mode is used inside organizations to grant access to users that have existing Windows domain accounts. Active Directory account creation mode can be used by Internet service providers to create unique accounts for customers using the Active Directory directory service.

In domain account mode, you use existing domain user accounts. If you choose Active Directory account creation mode, you are choosing to have accounts automatically created in the Active Directory organizational unit you specify. In either mode, you use the same methods to manage users of a site. You add them to the site by using their existing domain or Active Directory accounts, and then assign them to site groups to give them the rights they need to use the site.

The choice between user account modes is a one-time-only choice because it affects how the configuration database for your server or server farm is created. You cannot change user account modes after creating the configuration database, and this step is one of the first choices made during installation when using Microsoft SQL Server. If Windows Microsoft SQL Server 2000 Desktop Engine (WMSDE) is used, the account creation mode is set to domain account mode and cannot be changed.

In a Windows 2000 or Windows Server 2003 domain, Windows SharePoint Services can use Active Directory account creation mode. In a Windows NT domain, the domain account mode is needed.

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I did bold "You add them to the site by using their existing domain or Active Directory accounts, and then assign them to site groups to give them the rights they need to use the site." which means in both mode we have to add them using their existing accounts which means we have to create them first we have to access the server and then add into active directory on server and then come back to the sharepoint web interface and go to user manager interface and add them to site.

Please, confirm what I write? I am confused here if we reinstall everything and we won't get what we want then it is useless to do all that. Also clear that, do we have to reinstall WSS only to change that mode or do we have to reinstall both SPS and WSS?

In ADCreation mode, WSS will create the accounts. It is a single, web-based operation to add accounts.

Pretty cool how it has that capability. We typically don't use this namely for the reason that we prefer to have a better idea of just how many users there are on our domain.

Active Directory account creation mode is not supported when you install Windows SharePoint Services to a domain controller computer.

This links explains all the steps to Follow:
www.microsoft.com/.../stsc05.mspx?mfr=true

This links explains all the consideration by using AD account creation mode:
www.microsoft.com/.../stsd01.mspx?mfr=true

Here is the configuration;

1- We need to installed Domain Controller on a seperate computer and create a seperate organization unit for external users
2- Installed SQL Server on different machine
3- Then installed Windows Sharepiont Services on a new machine which does not have Domain controller
4- Test the WSS and Domain Controller setup before installing SPS
5- Then install SPS on the same machine where you installed WSS