Start with a vector version of the flag — one is available here:
Begin by drawing in a surrounding rectangle which is adequately larger to allow one to have some working room:
(Note that the next step will be easier if the rectangle lines up with the grid and snap to grid is turned on — adjust dimensions/placement as appropriate)
Draw in shapes using the polyline or curve tool which will define the midpoints of each ripple in the cloth:
Assuming one has the stock thickness set to 2" (50.8mm), begin the 3D modeling by adding the rectangle at half that thickness (25.4mm) as an initial median:
