Although I don’t myself use Differencing Disks a great deal for my test environments (mainly as I spent a while building set of about eight finely tuned VMs serving my needs for just about every demonstration), they are a great feature of Virtual Server and Virtual PC. One day, I’ll go through the steps to use differencing disks, if for no other reason than to get all eight VMs to fit on a single DVD – now that would be cool.
I stumbled across a walkthrough of setting up a VM using a differencing disk here. Worth a read if you get a chance. The one thing which I think should be added is to remember to mark the parent disk as read only (by ACL as well if you’re paranoid to really make sure). This is such a common mistake by many and so, so important. If you accidentally were to change the parent, you would render any children unusable.