If you go the Dell PC Restore route, it will wipe the machine (including any current bloatware) and restore the machine back to the exact state it was when you took it out of the box. This will include bloatware that may have been installed on it by Dell at that time. However, Dell is better than most in this respect - they (unlike HP, for instance) usually don't go crazy with bloatware, and all you normally have to do is to uninstall the software you don't want from add/remove programs. If this option is available, I suggest going with it as it is the simplest to complete.
If your machine came with a Dell Windows XP restore disc, this will reinstall Windows XP itself but without any of the other software that came with your machine. It also may render the Dell PC Restore process unusable. I'd suggest that before you go this route you download all the most recent drivers from the Dell website for your E520 and burn them to a CD so you can access them if needed (i.e. nothing is more irritating than imaging your machine, then finding you can't access the Internet because you don't have the Ethernet driver for your motherboard). You may also want to download and save the various service pack installers from the Microsoft website as well (you can get downloadable versions for network installs; other than being large downloads, they'll work just fine on single machines). Since you are re-imaging, now is also a good time to bring the BIOS up to date if you haven't updated it before (though, if you aren't having any problems, you may not want to mess with it either...).
As far as your software goes, it isn't possible to back up individual installed programs - you'll have to re-install them from the original CDs then apply (if any) subsequent patches needed to ensure they work right. If they came in the form of electronic downloads, you'll want to make sure you save the installers and the product keys. You may be able to back up things like saved games - you'll probably want to google each particular program to see what specifically you need to save and where to find it.
I recommend getting a decent external USB drive. Once you have the OS installed and reconfigured just like you like it (including installing any software that you always install on your machines), image it with Clonezilla or some other software of your choice to create a quick restore image. This will speed up future restorations of your OS by several orders of magnitude over what you have to do this time.
All in all, it is a lot of work. However, you'll usually be shocked at how much better your machine runs after the restore.