0) Uninstall any existing versions of Ruby
If this is your first time setting up the development environment you can skip this step, if you are trying to switch Ruby versions or are troubleshooting an issue you might already have Ruby installed and not care much about uninstalling it, maybe you have the Heroku toolbelt installed (if you are using that hosting service) which comes with its own Ruby installation (normally Ruby is installed at C:\Ruby, the Heroku toolbelt Ruby installation is at C:\Program Files (x86)\ruby).
Find any existing Ruby versions and uninstall them:
Control Panel\Programs\Programs and Features
(copy and paste the line above into the address bar of a Windows Explorer window)

After uninstalling delete the remaining Ruby folder and make sure the path was removed from the system variables to ensure a clean uninstall.
System variables path is found at:
Control Panel\System and Security\System

The path entry is composed of a single line with each item separated with a ;
A path that is added there will have its files available for programs and for you to execute without knowing their location (full path).
In the case of Heroku toolbelt I had one development machine that failed running 'bundle install' (more on this later) and the fix for it was removing the C:\Program Files (x86)\ruby item from the system variable path so it won't prevent the development kit (more on this later) files from being found when a gem installation required the build tools from the development kit that was installed at the C:\Ruby location...
1) Install Ruby
RoR applications are built with the Ruby language, this is the first step.
The latest Ruby version is available at:
http://rubyforge.org/projects/rubyinstaller/
If you need a specific version (your hosting service might require a specific version) you can get it from here:
http://rubyforge.org/frs/?group_id=167
2) Install RubyGems
Gems are libraries that are shared among Ruby projects, RubyGems helps us download and install those gems on the development machine where we installed Ruby.

gem update --system
this should work because the C:\Ruby\bin path should be set in the system variables when we installed Ruby.
3) Install Rails
This is the step that inspired me to write this blog post, if you follow the instructions at:
http://rubyonrails.org/download
then this step will fail.
You need to install the development kit, so lets try again.
3) Install Development Kit "One Click Install"
http://rubyinstaller.org/downloads/
Run the Development Kit "one click install" executable file, that will prompt you asking where to extract some files - point it to the path you installed Ruby at e.g. C:\Ruby
Go back to the command line and navigate to the Ruby installation folder, then type:
ruby dk.rb init
This will generate a file called config.yml
Now there is an optional step that could be useful if you are trouble shooting - type:
ruby dk.rb review
This will show you a list of Ruby installations that have been found - if this doesn't seem right you can fix it at the generated config.yml file.
Finally complete this step by running:
ruby dk.rb install
4) Install Rails
In the command prompt type:
gem install rails
Done.
Now you should be able to start developing rails applications, I would have liked to use Netbeans (my favorite IDE) but it seems that the RoR plugin for Netbeans doesn't run on the latest version... to get quickly up and running type in the command line:
gem install redcar
and then:
start redcar
This will get you started with a tool to edit the code and view the project files.
To generate a new project type in the command prompt:
rails new path/to/your/app
Gems that are required by your application are declared in the projects Gemfile, to install the gem dependencies of your application navigate to the projects folder in the command prompt and type:
bundle install
To run a local server to test your application, navigate to the application folder in the command prompt and type:
rails server
(can also type 'rails s' instead )
Once the server is ready Windows might prompt you about allowing it through the firewall.
Browsing to http://localhost:3000 should take you to your application.
Soon enough you will want to use a relational database, lets walk through setting one up - download PostgreSQL from:
http://www.postgresql.org/download/

Right click 'Login Roles' to add a new role for your application to use to login to the database, the role name could be something like myAppRole.
Right click 'Databases' to add two new databases - one for development and one for testing, use the dropdown to set the Owner to be the role you created in the previous step. The databases names could be something like appname_development and appname_test.

gem 'pg'
Make sure all the gems your application needs are installed by navigating to the application folder and runing the command:
bundle install
To configure the database connection open appfolder\config\database.yml and set the adapter to postgresql, set encoding to unicode, set the database to the name of the data base you created with pgAdmin and the username and password to the role that you created with pgAdmin.
The top of the file could look like this:
development:
adapter: postgresql
encoding: unicode
database: myApp_development
username: myAppRoleName
password: myAppRolePassword
pool: 5
timeout: 5000
This should be all you need to start using a relational database in your application... once you do, you will have migration files that could be used to setup the database with the tables your application needs - to do that navigate to the application folder and run the command:
rake db:setup
Good luck!