In win2k, with SP2 and the new *updated* apppatch, I can get the config program to pass 8 bit software textures. That's with a Neomagic 2mb card on a p2 266. I've played *through* the game on the laptop with win98se, but since I have a 6.4gig drive and have Win2k/Mandrake 8.1 dual, I have no room to be doing Mickey Mouse stuff with msft.
There's a couple of patches out, one's Cyrix and the other is some kind of vid card patch. I use the latter one, but I've never looked closely at it. FF7 was made with Voodoo in mind, and in my experience with desktops, Ati Rage Pro and Voodoo2 never mix.
I think you may have better luck if you upgrade to XP, since I've heard a lot of people can play it default (no patch; no service pack; load and go). But since XP has had that huge security bug since it's inception, I'm kinda' getting mixed feelins'...