Here's a page on the Wiki that describes how water currently functions:
FlowBasically, water blocks teleport from where they are to a contiguously connected open tile. That does mean that it could / will skip across quite a wide area though, which causes some funny issues with exactly how flow works in the middle of a lake with input on on end and output on the other for example (read: it doesn't really). Natural flow in rivers and streams (which can be used to power water wheels) works somewhat differently, but that seems to be a hard coded thing.
It's not exactly a perfect system and you do get some strange artifacts from time to time, but considering how well it compares performance wise to the alternatives (a purely
cellular automaton based system for example), it's probably the lesser evil. At least this way the water flows at least semi-naturally. And as an added bonus, pressure works!
So it's a good suggestion to make water more realistic, but I'm not sure how practical it actually is from a performance standpoint. Water is hard to do in just about any game like this. At least it's better than how Minecraft does it though.
So far as flooding, that would be neat--either natural river flooding or perhaps flooding based on torrential rains. Interestingly, the first was actually in much older versions of DF (specifically the 0.23.130.23a release and earlier), back before the z-levels and when there was a consistent order of things you found in a mountain. The
river flooded yearly, and was capable of sweeping dwarves and items off of bridges and off into the mountain.
If you want to see what other people have thought about floods, it's been discussed several times before:
(These are from the first page of searching 'flooding' in the search box up at the top right. There are about 12 more pages...
It's a pretty popular idea.)