This paper presents waypoint guidance based planar path following and obstacle avoidance for Autonomous Underwater Vehicles (AUV). Guidance through waypoints by line-of-sight (LOS) method and artificial potential field method (APFM) are used to develop the algorithm. Both LOS and PFM are simple and computationally inexpensive and can be used for real-time implementation. The basic LOS method has been modified for reference heading correction with a distance threshold in order to achieve minimal calculation for heading correction and smoother vehicle turn during course change at waypoints. An improved potential field method is also proposed for better obstacle avoidance for the AUV. Few points are taken from the path generated by the waypoint guidance and given as via points for the obstacle avoidance algorithm. The proposed algorithm basically follows the improved LOS method when there is no obstacle along the vehicle's path and switches to APFM when any obstacle is detected. The details of the algorithm and simulation results are presented.