What exactly is lost by flashing the FS?

[niteowl]

But that will only happen if I have those files in the phone's internal memory right? if I have them on the memory card, they will still remain there, correct?

Yes sure. Flashing FS will only affect the phone's internal memory, not the memory stick.
You can always pull the memory stick off and flash the phone's FS, after all (obviously it is not a necessary precaution). ;)