Sara Crewe has to leave her beloved childhood home in India when her wealthy father enlists to fight for the British in World War I. He enrolls her at Miss Minchin's Seminary for Girls in New York, and spares no expense to make sure his daughter will be comfortable while he is gone. Though she finds the strict rules and harsh attitude of the headmistress stifling, Sara quickly becomes popular among the girls, including the African-American servant girl Becky, for her kindness and strong sense of imagination.
Due to a body being misidentified, Captain Crewe is declared dead and has his assets seized by the British government, leaving Sara penniless. With no money and no known living relatives, she has no choice but to earn her keep at the boarding house by becoming a servant. All her possessions are confiscated from her and she’s moved to the attic with Becky.
Meanwhile, the elderly neighbor Charles Randolph has recently received word his son John is missing in action. He is asked to identify a soldier suffering from amnesia, but is disappointed to discover it is not John. His Indian assistant Ram Dass encourages him to take in the man anyway, reminding him that he may know what happened to his son.
Though her life is bleak, Sara remains kind to others and continues to hold onto her belief that all girls are princesses. When her friends sneak up to see her and are caught by Miss Minchin, she protects them by saying she invited them. As punishment, Miss Minchin locks Becky into her room and assigns Sara to perform both Becky's and her own chores for the next day, without anything to eat for both of them. To distract them from their hunger, they imagine a huge banquet. The next morning they wake to find their dream has come true, having secretly been left there by Ram Dass.
When Miss Minchin discovers all the finery in their rooms, she assumes they somehow stole it and summons the police. Sara narrowly avoids arrest by perilously climbing over to the Randolph house. While hiding from the police searching the house, she comes across the soldier and realizes it is her father. Though Miss Minchin recognizes him, she refuses to identify the man, allowing Sara to be taken away. Just as the girls are about to be hauled away by the police, Captain Crewe's memories return, saving them.
The Crewes' fortunes are restored to them, and they adopt Becky. The Captain tells Mr. Randolph his son died in a gas attack, giving the man closure. The boarding school is removed from Miss Minchin's care and given to Mr. Randolph, becoming a much happier place. After saying goodbye to all the girls, Sara leaves with her family to return to India. Miss Minchin is later seen reduced to a chimney sweeper working for a boy she previously mistreated.