Here's my desk setup for when I work in watercolors. Lately I've been penciling my final sketch onto a sheet of computer paper, taping it to my lightbox and then putting the watercolor paper on top. I paint directly over the sketch without having to pencil it onto the watercolor paper. I start with the lights and use liquid mask/frisket in the areas that I want to stay white. Once all the painting is done, I peel off the frisket and do the final lines with black India ink and a brush.
Here's a nifty movie I made with photos I took during the process. It's a bit choppy because I only decided to do it this way right now and my camera angles weren't quite all the same.