Install Ubuntu on a USB Flash Drive

You can install directly to the stick, but some initial preparation of the stick is desirable. Note the recommendations in the link:
 http://wiki.laptop.org/go/How_to_Damage_a_FLASH_Storage_Device
I know of no way to really tell how large the erase block should be on a usb device, but using 128k seems to work fine on 4G sticks. Additionally, I move /tmp and /var/log into ramdisks, and have links to ram from several other places like my user browser cache, and /var/cache/apt/archives for package downloads. I think you'd be better off without the 1G FAT, the 4G disk is pretty tight when large updates occur, although I do have a .5G home directory. No swap. The default ext2 filesystem's parameters are OK (I don't want journaling). Here's the fstab mods for ramdisks,(add right after /proc):

tmpfs /tmp tmpfs size=256M,mode=1777 0 0
ramfs /var/log ramfs mode=755 0 0

I do some tweaking in rc.local to set up some other things like a user whose home is in ram.
Backup your files regularly, I have used 4G sticks daily for more than 2 years with no problems, but have seen a 2g card burn out on a Windows PC just trying to copy in user directories (after about 300Megs).