Your number 2 definitely will not work, and you shouldn't bother going down that route.
So the first issue you might have is you may be trying to build the wrong image, there are two Nexus 7s. Grouper is the designation for the first generation Nexus 7 and Flo is the designation of the 2013 Nexus 7, so make sure you have those right.
The second issue you may be having is the build may be failing. Are you sure that your make completed successfully? Your final message should say something similiar to
Install system fs image: out/target/blah/blah/blah/system.img
If you didn't see a line like that your build failed in which case you should diagnose that.
The third issue is you may be pointing at the wrong file. The line you are giving expects a full package, and you may not have created one. Try doing this instead:
sudo su
. build/envsetup.sh
lunch aosp_flo-userdebug
fastboot flashall -w
This will look for the generated files from the build automatically without you having to point at them, so long as you have selected the proper lunch option. Another issue you may be having is you may be confusing your shell with sudo, I am guessing you haven't bothered setting up the proper USB Permissions (see configuring USB access on the AOSP Build Guide. If you don't want to bother setting up USB permissions, then just initialize your environment as the super user after you have built when you need to flash (not before, or all your files will belong to root!)