The easiest way is to use a small router, like a trim router, then clamp a board as a guide on the wood (in the right location) and run the router against the board to get a straight cut.
Move board to make next cut, or use two boards, one on each side and just move the router between the two until you cut all you need to. Use a chisel to square the corners.
Of course, you don't want to cut too deep. If you're using wood inlay and not veneer, plan for maybe 1/16 to 1/8". The piece you inlay should be a bit thicker so you can reduce it and not the field wood.
If you want to do it by hand, still use the guide board but make a cut with a knife along the board first, then use a chisel to drive downward. Do it on both sides, then chisel the center out. If not deep enough, you don't have to use the guide board any more, just use your cut as a guide. You can use a router plane to get the bottom flat.
It's really not too difficult. I much prefer the powered router approach.
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