Noobie Audio Confused.

http://telecom.hellodirect.com/docs/Tutorials/AnalogVsDigital.1.051501.asp

  Not a bad explanation.  

Yeah, your prelude is your DAC and your Harman is your amp.

Generally, the biggest upgrades are headphones > amp > DAC > Cables (if you're a believer)

 Your understanding is totally correct. I use my Onkyo AVR receiver fed from my X-Fi through a coax SPDIF cable. I use that configuration to listen to my music through my speakers. When I want to enjoy my music deeper and more personal, I switch to my uDac fed from USB to my little CKKIII amp and to my phones. Viva la choice !

Pico DAC!

I recommend you read this thread before getting a dac.

http://www.head-fi.org/forum/thread/491256/how-much-of-a-realistic-improvment-from-soundcard-to-dac-amp

A DAC is in essence  a chipset converting digital to analogue

If you connect an amp to the analogue out of your sound card, you are using the DAC of the sound card

If you connect the optical out (or coax) of the sound card to a receiver, you are sending SPDIF (a digital audio protocol) to the receiver. In this case you use the DAC inside the receiver.

More details on how a DAC works: http://thewelltemperedcomputer.com/KB/DAC.htm

There are a couple of scenario’s

1 Sound card > digital out > DAC (receiver) > Amp (receiver)

2 Sound card > analogue out (using the DAC of the sound card) > analogue in AMP

3 Sound card > digital out > External DAC > analogue in AMP

I suggest to compare 1 and 2 just to find out if you can hear a difference.

If so, you at least have an impression of what a DAC possibly can do in your system.

If not it might be that both DAC’s are equal or your headphone is not able to resolve micro details.

Personally I do think that buying  a 500,- DAC  in combination with a 200,- headphone is not a wise investment.

In general the transducers are the weakest link. Probably spending 500,- on a HD650 or so gives you a greater improvement in sound quality

But most of all, experiment, borrow some gear and compare, try to find the weakest link

Roseval got there before me, but I was going to say.  If you're using the optical output, you're just using your sound card as a Transport, and you're receiver is the DAC.  Following this same path, you'd gain very little upgrading the transport section (ie: soundcard).

The problem with using a soundcard for a transport to a receiver or numerous.  First, if you want surround for your games or other media, you will have to use an encoder which produces lossy audio.

DVD's will work with passthrough.

Some people assume that digital to a receiver from a soundcard is always better but that is just not true.  It depends on which device has the better DAC, the soundcards or the receivers S/Pdif input section.

Most modern soundcard use vry high quality DAC's and many low to mid grade and even some high grade receiver use cheaper DAC's for their input sections.  That is not to say the receiver doesn't sound good just many companies seem to skimp on this part for whatever reasons.  IF you have a receiver with both analog an digitla connections, it is best to test both and use your ears to decide which is best.