Whats the best way? Just leave it as a 404 error document page? At moment I have this in my htaccess ErrorDocument 404 / ErrorDocument 403 / Which fowards 404's to the main page - With that code does the SE bot know its a 404? Is that an ok way to do things?
The SEs are going to get a 404 regardless, but showing your index page isn't such a great idea IMO. You are better off putting a "not found" page up with a javascript redirect after a couple of seconds, and better yet, send them to a search page. You could also make your 404 page pretty and put a search box on it and links to your home page or other important pages, but keep it light. Keep an eye on your logs for 404s and you may find you should update your 404 page with the right address for anything common or even provide a 301 redirect for those pages.
I find when I redirect 404's to my index, they don't show up properly in my stats (awstats), then I cannot find problems with the site.