First shown in a flashback by Cloud to his party at the inn at Kalm after escaping from Midgar. Although Cloud's version replaces himself with the role of Zack. The truth isn't told until later in the game when Cloud and Tifa enter the Lifestream in Mideel.
On a mission to investigate and rid Nibelheim of it's recent monster activity, Shinra sends Sephiroth, Zack Fair, and Cloud Strife (who's identity is hidden by his Shinra Uniform Mask) to take care of the problems. Cloud is embarrassed that he never made it into SOLDIER and is just a lowly Shinra grunt so he does not visit his family or even tell Tifa or her master Zangan who he is until the problem at the Mako Reactor.
After Sephiroth loses control after finding out the truth of his past at the library in the Shinra Mansion and the Mt Nibel Reactor, he goes on a Rampage and sets the town on fire, killing most of the towns people.
When Cloud's party makes their way to Nibelheim after Cosmo Canyon, it seems that Cloud knows no one in town and everyone denies his recollection of what happened. It would seem that after the incident told in Cloud's flashback that Shinra rebuilt the town and filled it with people so that the truth did not come out into the open.
This is the town where you find Vincent Valentine
in Final Fantasy VII. He is locked in a coffin in the Shinra Mansion after Hojo
performed experiments on his body. After figuring out the combination to the safe and fighting the boss, the party will gain a key to the room in which Vincent resides in sleep. After talking to Vincent he will join the party after their encounter with Sephiroth. Vincent is a secret character and if the party does not open the safe to get his key (to meet his requirements to join), like Yuffie Kisaragi
, he will not become a party member.
Tifa's Final Heaven
Later on in the game if Cloud goes into Tifa
's house and plays (X, Sq, Tri, R1 Tri, R1 Sq, X, Sq, Tri, R1 X, O, X, Sq, X) on the piano in her room he will get her Level 4 Limit Break
Final Heaven. If he does this in his flashback he will get nothing, and if he does this on his party's first visit to the town he will get a small amount of Gil
hidden under key.
During Cloud's fashback he can go into Tifa's room and take a pair of her panties from her dresser.