How do I install a new operating system using an external hard drive instead of a DVD?

I am upgrading my OS from Vista Home Premium to Windows 7 Ultimate. My external hard drive has a bunch of files on it (backing up all my files) and also an ISO image of the Windows 7 boot-disk copied to it. How do I make my computer boot from the drive and install Windows 7? Is it okay for the drive to have multiple files on it, or does it have to have just the ISO image? Thanks for your feedback.