Via Finder I can see that it is really only 40 GB, so it is not hogging my entiire HDD, however I cannot resize it down to say 50 GB to overcome the space warning in Windows. It appears as a single 40 GB file in Finder.
Once a virtual hard disk has been partitioned it cannot be resized downwards only upwards! 
(That is the size of the virtual hard disk itself, not the size of the virtual partition(s) on the virtual hard disk.)
nor can I split it into 2 GB files (which would be great so only the relevant files get backed up via Time Machine!).
Time Machine backups the entire virtual hard disk every time it changes which is every time it's run and besides that...
It is a known fact that Time Machine is not 100% reliable backing up/restoring Virtual Machines under all circumstances/conditions. Also backing up Virtual Machines via Time Machine is disk/time intensive and wastes a tremendous amount of space for something that may be corrupt and worthless come time to restore it. At a minimum I would exclude Virtual Machines from Time Machine and with the Virtual Machines shutdown, not suspended, and VMware Fusion closed then manually copy the Virtual Machines Package(s) to an alternate location, preferably on to a different physical hard disk. Then keep the User Data that is stored within the Virtual Machine backed up off of the Virtual Machine on a regular basis so as to always have a current User Data Backup. If you have to restore a properly backed up Virtual Machine that is not as current at least you'll have a working Virtual Machine and current User Data to go forward with when you find out your Time Machine Backup of the Virtual Machine fails! 