Set in the 1910s, the story opens with a Grand Prix race, in which one of the cars swerves to avoid a dog, loses control, crashes, and catches fire, bringing its racing career to an end. The car ends up in an old garage, where two children, Jeremy Potts and Jemima Potts, have grown fond of it, but are told by a frequent customer, a junkman that he and his business intends to buy the car from the garage owner Mr. Coggins, for scrap; to crush it into one solid, then melt it down to a liquid and have the metal to sell. The two children, who live with their widowed father Caractacus Potts, an eccentric inventor and his equally peculiar parent, implore him to buy the car before the junkman does, but he is unable to, not having the money. While skipping school, they meet Truly Scrumptious, a beautiful upper-class woman with her own motorcar, who brings them home to report their truancy to their father. Truly shows interest in Caractacus' odd inventions, but he is affronted by her attempts to tell him that his children should be in school.
One night, while going over his bizarre inventions, many of which seem to be similar in function and form to modern appliances, such as vacuum cleaners and televisions, Caractacus discovers that one of the sweets he has invented can be played like a flute. He tries to sell the "Toot Sweet" to Truly's father Lord Scrumptious, a major confection manufacturer, but when the factory is overrun by dogs responding to the whistle, he is thrown out. Then he takes his automatic hair-cutting machine to a carnival to raise money, but it goes haywire. He eludes the wrath from his first (and only) customer named Cyril by joining a song-and-dance act, stealing the show and earning enough tips to pay for the car. Potts rebuilds the car, which he nicknames Chitty Chitty Bang Bang for the noises its engine makes, and he and the children, accompanied by Truly, go for a picnic on the beach, where Truly becomes very fond of the Potts family and vice versa. Caractacus tells them a story about nasty Baron Bomburst, the tyrant ruler of fictional Vulgaria, who wants to steal Chitty Chitty Bang Bang and keep it all for himself:
In the story, the quartet and the car are stranded by high tide, but Chitty suddenly deploys huge flotation devices and they escape inland. The Baron sends two comical spies ashore to capture the car for him, but they briefly capture Lord Scrumptious by accident, and then kidnap Grandpa Potts, mistaking him for the inventor of Chitty. Caractacus, Truly, and the children see him being taken away by airship, and give chase. When they accidentally drive off a cliff, Chitty sprouts wings and propellers and begins to fly. They follow the airship to Vulgaria, where the Baroness Bomburst has ordered the imprisonment of all children, whom she abhors. Grandpa the "inventor" has been ordered by the baron to make another floating car, and is bluffing to avoid being tortured. The Potts party is hidden by the local toymaker, who now works only for the baron. Chitty is discovered and taken to the castle. But while Caractacus and the toymaker go in search of Grandpa and Truly goes in search of food, the children are captured by the Baron's Child Catcher.
The toymaker takes Truly and Caractacus to a grotto far beneath the castle where the townspeople have been hiding their children, and they concoct a scheme to free the children and the village from the baron. The toymaker sneaks them into the castle disguised as life-size dolls, gifts for the baron's birthday. Caractacus snares the Baron and the town's children swarm into the banquet hall overcoming the baron's palace guards and guests. In the ensuing chaos, the baron, baroness, and Child Catcher are all captured. The family is freed and fly back with Truly to England. Jeremy and Jemima finish the story themselves: "And Daddy and Truly were married!" which Truly seems to find appealing, but Caractacus is evasive, believing that the class distance between them is too great. When they arrive home, Caractacus is surprised to find his father and Lord Scrumptious (who it turns out are old army friends) playing a lively game of soldiers. Scrumptious surprises him further with an offer to buy the Toot Sweet as a canine confection and, realising that he is soon to become wealthy, rushes off to propose to Truly. As they drive off together in Chitty, the car takes to the air again, this time without wings.