I've done all three methods when installing flares on the rear of the S30 and here's what I have learned:
1. You might as well cut the wheel well up to the attachment holes on the ZG flare. Leaving any metal below that just leaves you vulnerable to having to go back and cut/weld some more once the wheels and tires are fitted and the car is loaded with people and stuff.
2. The ZG flares can only be moved up an inch or maybe 1.5" from where they are designed/molded to fit.
3. Either of the three methods will work and it mostly depends on what you're comfortable with (welding or pounding), how straight the 1/4 panel is to begin with, and how clean you got everything (you can pound dirt, you can't weld it).