Make a file system on it with bin, etc, lib and dev directories—everything you need. Install a kernel on it and arrange to have LILO boot it from the floppy (see the LILO documentation, in lilo.u.*.ps).
If you build the kernel (or tell LILO to tell the kernel) to have a RAM disk the same size as the floppy the RAM disk will be loaded at boot time and mounted as root in place of the floppy.
See the Bootdisk HOWTO.