Or if you are lazy like me, and want a program to do it for you...
**broken link removed**
Before you do, check out the links made by ckshivaram above..
There are several lite versions of xp & windows 7 made to run off flash drives that are scaled down to fit on a flash drive..
I am doing the same thing you are doing on a wyse thin client terminal for majicjack.
You might have better luck posting in the proper area. This section is for Hobby Circuits and Small Projects Problems. Like here
Follow all the steps given in the link Hiren's BootCD From USB Flash Drive (Pen Drive). Did you set USB flash as first boot device in BIOS.? It works I did it my self. If Boot CD 14 is not working try it with older version like 9 or 10. If it is still not working let me know what is the problem.?