Perhaps it is best to start with information about pregnancy. Expectant parents can read books about how baby's develop in the womb with their toddlers, and show pictures of when mom was pregnant with the "Spanish Inquisitor". You may like to take your child to one of your prenatal appointments so that he or she can see what the doctor or midwife does there, and perhaps to see the new baby on an ultrasound monitor. Young kids always love to see pictures of themselves when they were a newborn too. You can discuss how the baby comes out when he or she is ready, and then about how newborns need lots of sleeping and feeding, and may cry quite a bit at the beginning.
Now for the awkward part. One mom I know got the question about how the baby gets out unexpectedly. She replied that there was a "special door" through which the baby leaves. The toddler then proceeded to ask whether he could see the special door. Mom hastily added that it was a secret special door! To avoid this kind of situation, it may be good to show the process of labor and delivery in a biology book with drawings. You may discuss how the uterus (the little "house" the baby lives in until birth) helps the baby move out by contracting. You can show the process of contractions on a ball or balloon (just make sure it doesn't pop!). Then, you can get the biology book out and show where the baby comes out. Actual information about birth is important, because young toddlers may otherwise make up their own explanation about how babies leave the womb and those explanations can be a whole lot more awkward than the real deal.