Check out my most recent baby shower cake. For the "Baby" on there, I used this technique:
Print out on Word what you want. I used Times New Roman font in Bold at like 300pt. (I look at the ruler on the left and use that as a guide as to how high I want my letters so they will fit on the cake.)
Print it out, cut each individual letter out. Roll out your fondant and let dry a little. (I usually roll it out first, then print out the letters while the fondant dries.) Place each letter on the fondant and trace lightly with a toothpick. I put a little Crisco on the back of each letter to keep it in place while I'm tracing.
Take your exacto and cut each letter out. Let it dry a little more before putting on the cake so the letters don't warp as you pick them up.
Hope this helps!