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Fixing leaky windows?

I have an old cottage with wooden windows. We are having significant problems with leaks and it appears that the sand and cement used to plug the gap between the window and wall is crumbling away. I therefore need to make the gap water tight.

How exactly should I do this? I have some ready mix sand and cement, but understand that it won't adhere to the wood, so how do I treat the wood?

Do I need to mix PVA into the sand and cement, use it direct or, not use it at all?

All help appreciated from an enthusiastic total amateur.
Mr Bath, January 2009
Anyone? I'm stuck!

Mr Bath, February 2009