I turn on machine co-ord's and referece (zero) all axis,
Referencing and zeroing are two different things, which are you doing? And turning on machine coordinates does nothing for you. If you reference the machine (Ref All Home), the machine coordinates are zeroed whether they are active or not.
If you're actually trying to zero the axis, you can't zero machine coordinates. Machine coordinates can only be zeroed by referencing.
G41 D125 means to use the diameter of tool #125, not tool #1.
You either need to enter a diameter of .125 in tool #125, or, use the P word with G41.
G41 P0.125
You also need to use a lead-in move with G41/G42, or you'll get unexpected results.
I'm assuming you want to start from 0,0? In that case, don't switch to machine coordinates, just click the X zero and Y zero buttons.
You'll need to modify your g-code to have a lead in move where the compensation is applied.