What do Mormons mean by saying that we are 'literal' children of God

This is something that I too believe - but I think its meaning is not something that can be explained in a single proposition.

Here is my attempt to summarize it in five points, as best I understand it:

1. We are God's children by means of some spiritual process of procreation which involves the two sexes of the divine (i.e. a Heavenly Father and Mother).

2. We are of the same kind as God - of the same basic nature.

(In other words, there is a vast but quantitative distinction in the level or amount of divinity between God as creator, and ourselves as created by Him - but not an absolute division. This is partly because we are not created by God from nothing; but shaped and enhanced by God building-upon our selves as pre-existent primordial intelligences.)

3. That we are Sons and Daughters of God is therefore not a metaphor.

4. Because we are children of God, we have inherited the divine from Him (and Her).

5. Analogously that we are mortal Sons and Daughters who are distinct and autonomous persons in relation to our earthly parents; so also we are also potentially distinct divine persons in relation to our Heavenly parents.