It's totally up to you which way you prefer, whatever you will be comfortable with. For myself, I'd rather applique onto the fabric block first, especially if planning to hand blanket stitch, and do the quilting either as a Quilt As You Go (includes batting and backing), or later when all blocks are joined together, as a whole. If I did the applique by machine, including the batting would be my way to go, but I wouldn't like to stitch it down by machine (straight stitch) then try to blanket stitch by hand. But then this is only my preference.