Kalm & Nibelheim Flashback - FF7 Walkthrough
You'll find the town of Kalm just east of Midgar - you can actually still see Midgar from Kalm (as shown in my screen shot above). If you're having trouble locating this town I would recommend you use my screen shot below.
There is something you can do before going to Kalm, learn the Mantra Magic Enemy Skill from a Sweeper Custom A enemy... However I would recommend holding off on these things for now until you finish the story segments in Kalm and get the PHS. This will allow you to swap party members on the World Map with ease.
Right when you enter Kalm your party will leave you and the only way to get everyone back is to complete the Nibelheim flashbacks... Which is about 30 - 45min of story dialogue. Before heading into the Inn and starting all of that I recommend collecting the treasures around Kalm.
Use my two screenshots above to collect all there is throughout the town. Each building with treasure in it is marked and if you're having trouble finding the treasure, check the screenshots below. I uploaded a picture for each of the treasures in a location that isn't obvious.
When you're done collecting all of the loot throughout Kalm head to the second floor of the Inn. Everyone is waiting for you here and you'll begin the Nibelheim flashback.
During the Nibelheim flashback the only thing that you're going to want to make sure you do is jam on Tifa's piano. You get an opportunity to do this before speaking with Sephiroth and sleeping at the Inn. If you do this then later in the game on Disc 2 when Tifa is in control of your party you can return to Nibelheim and inspect this piano for an Elemental Materia.
As for the rest of the flashback, it's pretty straight forward. Do what's asked of you when prompted until you've finished everything. If any part has you confused or stuck check out my succinct list of all the steps below.
Nibelheim Kalm Flashback Story Steps:
1. Go into Tifa's House & jam on the Piano
2. Go to 2F of the Inn and speak with Sephiroth, spend the night
3. Talk to Sephiroth to begin the Mount Nibel expedition
4. Open the valve at the reactor then speak to Sephiroth & look in the pod
5. Back in Nibelheim go into the Shinra Mansion and down to the basement, speak with Sephiroth here
6. Return to the Shinra Mansion basement after you wake up and speak with Sephiroth again
Once you're done telling your story you'll want to leave the Inn to obtain the PHS from your other party members. Before leaving Kalm go back up to the second floor of the Inn and inspect the dresser behind the stairwell (screenshot below). You'll get a dialogue box that pops up but says "I can't reach it" - keep inspecting the dresser a total of 5 times and Cloud will get pissed off and kick it, netting you the Megalixir.