Floor washable if you are doing crafts so if laying down vinyl is out then at minimum you can put down the peel and stick tiles. I would stay away from the foam mats because of the girls and craft supplies getting lost between the tiles. Walls could be covered in cheap pannelling - in a light colour. Which could also be painted. I cheated in one house and made a sewing area nice by wallpapering over the drywall and putting a piece of molding where the seam was and screwed hooks into it for hanging stuff.

Consider getting shelves and putting them back to back down the centre of the room with crafts on one side and other stuff on the other and then a table for games or puzzles. Add a few old pillows for reading or sitting and playing nintendo or other hand games.

A monitor of video system so you can know what is going on even while you are still upstairs clearing from lunch etc.