The area was first settled by Europeans in 1837 by Hugh Murray (died 1869) and his brother Andrew (died 1889) in 1840, and proclaimed a town, Lake Colac, in 1848.
The plains around Colac are the third largest volcanic plain in the world. Australia's largest permanent salt lake and Victoria's largest natural lake, Lake Corangamite, is nearby and Red Rock Reserve is nearby too.
Lake Colac's water level can drop over summer dry periods to the point that it actually dried up for the first time in recorded history in 2009, but is always replenished after drought and is used for fishing, boating and water skiing.
The Princes Highway (part of Australia's circumnavigational Highway 1) runs through the city and forms its main street, Murray Street. The highway runs west toward Camperdown and east to Geelong and beyond to Melbourne. S
everal secondary sealed roads including the C161, C155 and C154 run south toward Apollo Bay and the coastal tourism areas of the Otway RangesGreat Ocean Road, The Twelve Apostles and the Shipwreck Coast. The Colac-Ballarat Road runs north connecting Colac to Ballarat via Cressy.
A narrow gauge branch line also originated from the town, the branch line to Beech Forest opened in 1902 and was extended to Crowes in 1911, finally closing in 1962. The route of the abandoned railway has been developed as the Old Beechy Rail Trail.
Colac was the home of the annual "Cliff Young Australian 6-day race". The event, which was originally orchestrated by Stuart Walker, occurred for over 20 years until 2006 and is a running/walking event. It was held on the Memorial Square which is right in the heart of Colac and attracted entries from all over the world.
Also held at the Memorial Square is the annual Colac KANA festival taking place on the third Saturday of March. Many market stalls, children's entertainment and a song and dance stage can be found at the festival. The most popular feature of the festival is its parade through the streets of Colac's CBD.
The parade showcases local primary schools and their students as well as local clubs, emergency service organisations and businesses. 
With a wealth of natural resources, such as agriculture and timber, Colac has a strong manufacturing background, with major local employers including Bulla Dairy Foods, CRF Colac Otway Pty Ltd and AKD Softwoods.
While historically the region supported numerous successful brickworks, nowadays the major primary industries are agriculture such as the dairying, beef, lamb and finewool merino industries.