You use the FF7config.exe from the TNT patch....and only that file, don't copy FF7.exe...it will crash if you do.
Not neccesarily crash, but running the 1.00 executible has less screwed up crap on the screen. But it definately will crash in XP. Ooohhh yes...
Pinkfloyd is right. Running the game in TV-OUT (if your card can do it) makes everything look superb. Instead of thinking of the backgrounds as blocky, xeriouxi, think of them as ultra-sharp

Your efforts would definately be in vain trying to rip backgrounds/movies from the PSX version.
I mean honestly, shouldn't you be worried more about the skinny-elbowed models running around? They look even tackier in the low-res backgrounds, which don't look all THAT bad. Try some FSAA (full screen anti-aliasing) to see if you can do some damage.
Bring your daughter...To the slaughter