diff --git a/Sources/XcodeGenKit/SourceGenerator.swift b/Sources/XcodeGenKit/SourceGenerator.swift
index 932a0d4c..3a409b53 100644
--- a/Sources/XcodeGenKit/SourceGenerator.swift
+++ b/Sources/XcodeGenKit/SourceGenerator.swift
@@ -281,6 +281,7 @@ class SourceGenerator {
                 // Check equality by path and sourceTree because XcodeProj.PBXObject.== is very slow.
                 if !cachedGroupChildren.contains(where: { $0.name == child.name && $0.path == child.path && $0.sourceTree == child.sourceTree }) {
                     cachedGroupChildren.append(child)
+                    child.parent = cachedGroup
                 }
             }
             cachedGroup.children = cachedGroupChildren
@@ -394,7 +395,6 @@ class SourceGenerator {
         targetSource: TargetSource,
         path: Path,
         isBaseGroup: Bool,
-        createIntermediateGroups: Bool,
         hasCustomParent: Bool,
         excludePaths: Set<Path>,
         includePaths: Set<Path>
@@ -426,7 +426,6 @@ class SourceGenerator {
                 targetSource: targetSource,
                 path: path,
                 isBaseGroup: false,
-                createIntermediateGroups: createIntermediateGroups,
                 hasCustomParent: false,
                 excludePaths: excludePaths,
                 includePaths: includePaths
@@ -581,7 +580,10 @@ class SourceGenerator {
 
             let sourceFile = generateSourceFile(targetType: targetType, targetSource: targetSource, path: path)
 
-            if parentPath == project.basePath {
+            if hasCustomParent {
+                sourcePath = path
+                sourceReference = fileReference
+            } else if parentPath == project.basePath {
                 sourcePath = path
                 sourceReference = fileReference
                 rootGroups.insert(fileReference)
@@ -609,7 +611,6 @@ class SourceGenerator {
                 targetSource: targetSource,
                 path: path,
                 isBaseGroup: true,
-                createIntermediateGroups: createIntermediateGroups,
                 hasCustomParent: hasCustomParent,
                 excludePaths: excludePaths,
                 includePaths: includePaths
@@ -626,6 +627,7 @@ class SourceGenerator {
 
         if hasCustomParent {
             createParentGroups(customParentGroups, for: sourceReference)
+            try makePathRelative(for: sourceReference, at: path)
         } else if createIntermediateGroups {
             createIntermediaGroups(for: sourceReference, at: sourcePath)
         }
@@ -639,21 +641,24 @@ class SourceGenerator {
         }
 
         let parentPath = project.basePath + Path(parentGroups.joined(separator: "/"))
+        let parentPathExists = parentPath.exists
+        let parentGroupAlreadyExists = groupsByPath[parentPath] != nil
 
-        let hasParentGroup = groupsByPath[parentPath] != nil
         let parentGroup = getGroup(
             path: parentPath,
             mergingChildren: [fileElement],
             createIntermediateGroups: false,
             hasCustomParent: false,
-            isBaseGroup: false
+            isBaseGroup: parentGroups.count == 1
         )
 
         // As this path is a custom group, remove the path reference
-        parentGroup.name = String(parentName)
-        parentGroup.path = nil
+        if !parentPathExists {
+            parentGroup.name = String(parentName)
+            parentGroup.path = nil
+        }
 
-        if !hasParentGroup {
+        if !parentGroupAlreadyExists {
             createParentGroups(parentGroups.dropLast(), for: parentGroup)
         }
     }
@@ -681,6 +686,32 @@ class SourceGenerator {
         }
     }
 
+    // Make the fileElement path and name relative to its parents aggregated paths
+    private func makePathRelative(for fileElement: PBXFileElement, at path: Path) throws {
+        // This makes the fileElement path relative to its parent and not to the project. Xcode then rebuilds the actual
+        // path for the file based on the hierarchy this fileElement lives in.
+        var paths: [String] = []
+        var element: PBXFileElement = fileElement
+        while true {
+            guard let parent = element.parent else { break }
+
+            if let path = parent.path {
+                paths.insert(path, at: 0)
+            }
+
+            element = parent
+        }
+
+        let completePath = project.basePath + Path(paths.joined(separator: "/"))
+        let relativePath = try path.relativePath(from: completePath)
+        let relativePathString = relativePath.string
+
+        if relativePathString != fileElement.path {
+            fileElement.path = relativePathString
+            fileElement.name = relativePath.lastComponent
+        }
+    }
+
     private func findCurrentCoreDataModelVersionPath(using versionedModels: [Path]) -> Path? {
         // Find and parse the current version model stored in the .xccurrentversion file
         guard
diff --git a/Tests/XcodeGenKitTests/SourceGeneratorTests.swift b/Tests/XcodeGenKitTests/SourceGeneratorTests.swift
index 76af3b62..49458675 100644
--- a/Tests/XcodeGenKitTests/SourceGeneratorTests.swift
+++ b/Tests/XcodeGenKitTests/SourceGeneratorTests.swift
@@ -469,35 +469,41 @@ class SourceGeneratorTests: XCTestCase {
                 try pbxProj.expectFile(paths: ["../OtherDirectory/C/D", "e.swift"], names: ["D", "e.swift"], buildPhase: .sources)
                 try pbxProj.expectFile(paths: ["Sources/B", "b.swift"], names: ["B", "b.swift"], buildPhase: .sources)
             }
-            
+
             $0.it("generates custom groups") {
-                
+
                 let directories = """
-                Sources:
-                  A:
+                - Sources:
+                  - a.swift
+                  - A:
                     - b.swift
-                  F:
+                  - F:
                     - G:
                       - h.swift
-                  B:
+                      - i.swift
+                  - B:
                     - b.swift
                     - C:
                       - c.swift
                 """
                 try createDirectories(directories)
-                
+
                 let target = Target(name: "Test", type: .application, platform: .iOS, sources: [
+                    TargetSource(path: "Sources/a.swift", group: "CustomGroup1"),
                     TargetSource(path: "Sources/A/b.swift", group: "CustomGroup1"),
                     TargetSource(path: "Sources/F/G/h.swift", group: "CustomGroup1"),
                     TargetSource(path: "Sources/B", group: "CustomGroup2", createIntermediateGroups: false),
+                    TargetSource(path: "Sources/F/G/i.swift", group: "Sources/F/G/CustomGroup3"),
                 ])
-                
+
                 let options = SpecOptions(createIntermediateGroups: true)
                 let project = Project(basePath: directoryPath, name: "Test", targets: [target], options: options)
-                
+
                 let pbxProj = try project.generatePbxProj()
-                try pbxProj.expectFile(paths: ["CustomGroup1", "Sources/A", "b.swift"], names: ["CustomGroup1", "A", "b.swift"], buildPhase: .sources)
-                try pbxProj.expectFile(paths: ["CustomGroup1", "Sources/F/G", "h.swift"], names: ["CustomGroup1", "G", "h.swift"], buildPhase: .sources)
+                try pbxProj.expectFile(paths: ["CustomGroup1", "Sources/a.swift"], names: ["CustomGroup1", "a.swift"], buildPhase: .sources)
+                try pbxProj.expectFile(paths: ["CustomGroup1", "Sources/A/b.swift"], names: ["CustomGroup1", "b.swift"], buildPhase: .sources)
+                try pbxProj.expectFile(paths: ["CustomGroup1", "Sources/F/G/h.swift"], names: ["CustomGroup1", "h.swift"], buildPhase: .sources)
+                try pbxProj.expectFile(paths: ["Sources", "F", "G", "CustomGroup3", "i.swift"], names: ["Sources", "F", "G", "CustomGroup3", "i.swift"], buildPhase: .sources)
                 try pbxProj.expectFile(paths: ["CustomGroup2", "Sources/B", "b.swift"], names: ["CustomGroup2", "B", "b.swift"], buildPhase: .sources)
                 try pbxProj.expectFile(paths: ["CustomGroup2", "Sources/B", "C", "c.swift"], names: ["CustomGroup2", "B", "C", "c.swift"], buildPhase: .sources)
             }
@@ -988,7 +994,7 @@ extension PBXProj {
         guard !paths.isEmpty else {
             return nil
         }
-        
+
         let path = paths.first!
         let name = names.first!
         let restOfPath = Array(paths.dropFirst())