Error message says that sql server services should be running on the same machine.Is it that ADS and sql server should be running on the same machine and not on the remote ??

SQL Browser Service should be running on the same machine as the SQL Server.

Btw, we have enhanced the error message as follows:

"To make a connection using named instance, you need SQL Server Browser Service to be up and running. Aqua Data Studio could not connect to the SQL Server Browser Service on <server>."

I have started the SQL Browser Services and its up and Running and the version of the database which we have is

 Microsoft SQL Server  2000 - 8.00.760 (Intel X86)
Dec 17 2002 14:22:05
Copyright (c) 1988-2003 Microsoft Corporation
Developer Edition on Windows NT 5.1 (Build 2600: Service Pack 3).

But Still we are getting the same error message, please see attached screen shot which says the services is up and running.

@Rohit,

I am unable to reproduce this issue locally. I have sent you an email with some steps to diagnose this issue further.

Looks like the issue seen by QA is specific to MS SQL Server 2000. QA will create a separate issue to track the same.

Tested on SQL Server 2005